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Confidential (FR) Class II FOMC

August 18, 1982

RECENT DEVELOPMENTS

Prepared for the Federal Open Market CommitteeBy the staff of the Board of Governors of the Federal Reserve System

Section Page

DOMESTIC NONFINANCIAL DEVELOPMENTS II

Employment and unemployment................................... 1Industrial production ..................................... 3Personal income and consumer spending......................... 5Business fixed investment ..................................... 7Housing ....... ........ ................................. ... ... 11Inventory investment......................................... 13Federal government...................... ................... .. 16

State and local government...................................... 19Prices .... ......... ............... .................... ....... . 19

Wages and productivity........................... ............. 22

TABLES:

Changes in employment.......................................... 2

Selected unemployment rates................................... 2

Industrial production. ...... ............................... 4

Equipment output................ .... .......................... 4Personal income .................. .............................. 6

Retail sales............ . .................................. . 8

Auto sales......................... ..... ......... ....... 8Business capital spending indicators............................ 9Business capital spending commitments........,................ 9Private housing activity..................................... 12

Changes in manufacturing and trade inventories.................. 15Inventories relative to sales.................................. 15

Recent changes in consumer prices............................ 18Recent changes in producer prices............................. 18Selected measures of compensation, productivity, and costs in

the nonfarm business sector................................. 21Negotiated wage-rate changes under major collective

bargaining settlements........... ........................... 23

CHARTS:

Vacancy rates for commercial office space...................... 10Private housing starts........................................ 14

Housing: new and existing...................................... 14

Effective wage change in major union contracts.................. 23

APPENDIX: The Federal Budget at Mid-Session

DOMESTIC FINANCIAL DEVELOPMENTS III

Monetary aggregates and bank credit............................ 3Business finance............................ .................. 7

Government finance 11Federal sector.............. ... ................... 11

State and local sector.................................... 12

Section Page

DOMESTIC FINANCIAL DEVELOPMENTS III

Mortgage markets .................................... ........... 14

Consumer credit.................................... ............. 17

TABLES:

Monetary aggregates. ................................... ... ... 2

Commercial bank credit and short- and intermediate-termbusiness credit........................................ .... . 6

Gross offerings of securities by U.S. corporations.............. 8Treasury and agency financing................................... 10

State and local government security offerings................... 13Consumer installment credit ..................................... 16

INTERNATIONAL DEVELOPMENTS IV

Foreign exchange markets................................ ..... 1

U.S. international transactions............... .................. 5U.S. merchandise trade......................................... . 5U.S. international capital transactions.......................... 7Foreign economic developments............................. .... ... 11Individual country notes......................................... 12

TABLES:

U.S. .merchandise trade............................ ...... ......... 5

Oil imports........... ......... ........ .. ...... .... ....... .... 6International banking data....................................... 7Summary of U.S. international transactions....................... 10Major industrial countries

Real GNP and IP............................................... 20Consumer and wholesale prices..................... ......... 21Trade and current-account balances............................ 22

CHARTS:

Weighted-average exchange value of the U.S. dollar ............... 2Three-month interest rates.......................... ............. 2

August 18, 1982

SELECTED DOMESTIC NONFINANCIAL DATA

(Seasonally adjusted)

Latest data Percent change fromThree

Period Release Data Preceding periods Yeardate period earlier earlier

(At annual rate)

Civilian labor forceUnemployment rate (%) 1/Insured unemployment rate (%) 1/

Nonfarm employment, payroll (mil.)ManufacturingNonmanufacturing

Private nonfarm:Average weekly hours (hr.) 1/

Hourly earnings ($) 1/Manufacturing:

Average weekly hours (hr.) 1/Unit labor cost (1967=100)

Industrial production (1967=100)Consumer goodsBusiness equipmentDefense & space equipmentMaterials

Consumer prices all items (1967=100)All items, excluding food & energyFood

Producer prices: (1967=100)Finished goodsIntermediate materials, nonfoodCrude foodstuffs & feedstuffs

JulyJulyJuneJulyJulyJuly

8-6-828-6-828-13-828-6-828-6-828-6-82

July 8-6-82

July 8-6-82

110.59.84.7

89.818.871.0

3.69.54.6-.2

-5.71.2

34.9 34.8

7.70 7.66

July 8-6-82 39.3 39.2June 7-30-82 232.0 10.4

JulyJulyJulyJulyJuly

JuneJuneJune

JulyJulyJuly

8-13-82

8-13-828-13-828-13-828-13-82

7-23-827-23-827-23-82

8-13-828-13-828-13-82

138.1

144.5152.0109.0133.7

289.7277.0287.2

281.3316.0253.4

-.96.7

-24.710.0

.0

12.610.57.6

6.96.1

-32.7

3.2

9.44.3

-1.1

-6.9.5

1.77.23.4

-1.7-7.6

.0

34.9 35.37.59 7.27

39.0 40.011.0 11.1

-6.06.8

-31.36.7

-7.3

9.010.27.1

6.6

3.4-3.1

-10.3-4.2

-17.7

6.2-13.9

7.18.55.1

3.7

1.2-4.3

Personal income ($ bil.) 2/

Mfrs. new orders dur. goodsCapital goods industriesNondefenseDefense

July 8-18-82 2,592.3 11.7

(Not at annual rates)

($ bil.) JuneJune

JuneJune

Inventories to sales ratio: 1/Manufacturing and trade, total

ManufacturingTrade

JuneJuneJune

Ratio: Mfrs.' durable goods inven-tories to unfilled orders 1/ June

Retail sales, total ($ bil.)

GAF 3/

Auto sales, total (mil. units.) 2/

Domestic modelsForeign models

Housing starts, private (thous.) 2/

Leading indicators (1967=100)

8-2-828-2-828-2-828-2-82

8-12-828-2-828-12-82

8-2-82

July 8-11-82July 8-11-82

July 8-4-82

July 8-4-82July 8-4-82

74.724.7

19.35.4

1.491.711.29

.618

88.718.7

7.3

5.12.2

8-17-82 1,2117-30-82 127.9

-1.9-1.8-5.212.6

1.461.721.24

.611

33.7.0

-4.1-15.7-13.1-23.9

1.501.781.26

.608

.51.6

1.3

-6.023.1

-14.1-14.2-19.814.9

1.411.611.22

.574

1.62.0

-10.3

-13.1-3.2

37.3 16.42.2 -5.4

JulyJune

1/ Actual data used in lieu of percent changes for earlier periods.2/ At annual rate.3/ Excludes mail order houses.

II - T - 1

DOMESTIC NONFINANCIAL DEVELOPMENTS

The sharp decline in economic activity early in the year apparently

has ended, but there are few indications of an upturn. Industrial produc-

tion and employment were little changed in July. Retail sales so far have

shown only a little improvement from a depressed June level, and there is

evidence of a further weakening of capital outlays in the near term. On

the positive side, housing starts rose substantially in July, and initial

claims for unemployment insurance benefits have been somewhat lower in

recent weeks. Moreover, progress continued to be made in reducing the

underlying trend in inflation, with wage increases remaining moderate.

Employment and Unemployment

Nonfarm employment was about unchanged in July, as gains in trade

and services about offset the continued contraction in the goods-producing

sector. However, manufacturing employment continued to show weakness,

falling another 90,000 in July, and mining was off 15,000. The composi-

tion of the contraction in industrial employment has shifted since the

beginning of the recession when losses were concentrated primarily in the

construction and consumer durables industries. The declines at these

industries and at their suppliers have tapered off during the last

several months while layoffs in oil- and gas-well drilling as well as

in the industry that builds drilling machinery have become particularly

large. Overall, the layoff rate appears to be slowing. Weekly claims

for unemployment insurance, a measure of layoffs and leading business

cycle indicator, have averaged 40,000 lower through late July than in

the preceding two months--although they remain at a high level. The

manufacturing workweek also has edged up slightly.

II-1

II-2

CHANGES IN EMPLOYMENT1

(Thousands of employees; based on seasonally adjusted data)

1980 1981 1982Q1 Q2 June July

- - Average monthly changes - -

Nonfarm payroll employment2 14 -7 -113 -148 -306 -17Strike adjusted 8 -8 -111 -134 -280 -31

Manufacturing -62 -40 -119 -130 -186 -90

Durable -46 -32 -78 -95 -127 -48

Nondurable -16 -8 -41 -35 -59 -42

Construction -19 -22 -31 3 -46 -10

Trade 0 16 44 -18 -50 27

Finance and services 81 56 25 43 63 60

Government 11 -26 -19 -14 -36 33

Private nonfarm productionworkers -23 -8 -90 -111 -226 -37Manufacturing productionworkers -69 -48 -103 -104 -140 -50

Total employment3 -27 -2 -40 91 -353 -32Nonagricultural -35 22 -87 87 -223 -134

1. Average change from final month of preceding period to final month ofperiod indicated.2. Survey of establishments. Strike-adjusted data noted.3. Survey of households.

SELECTED UNEMPLOYMENT RATES(Percent; based on seasonally adjusted data)

1980 1981 1982Q1 Q2 June July

Total, 16 years and older 7.1 7.6 8.8 9.5 9.5 9.8

Teenagers 17.8 19.6 21.9 22.8 22.3 24.120-24 years old 11.5 12.2 14.0 14.5 14.4 14.4Men, 25 years and older 4.8 5.1 6.4 7.1 7.5 7.5Women, 25 years and older 5.5 5.9 6.6 7.2 7.2 7.4

White 6.3 6.7 7.7 8.4 8.4 8.7Black and other 13.1 14.2 15.9 17.1 17.1 17.3

Fulltime workers 6.9 7.3 8.6 9.3 9.4 9.5

White collar 3.7 4.0 4.5 4.9 5.0 4.9Blue collar 10.0 10.3 12.6 13.7 13.9 14.4

II-3

The unemployment rate climbed 0.3 percentage point to 9.8 percent

in July with most of the increase occurring among labor force entrants.

Unemployment remained high in July among adult men, reflecting the cumu-

lative job losses in the predominantly male industrial industries.

Although some adult women have continued to find employment in the still-

growing service-producing sector, their unemployment also rose in July.

While layoffs may be slowing, the prospects for rehiring appear a bit

weaker compared with earlier cyclical troughs. Only 19 percent of the

unemployed report that they are on layoff and expecting recall as compared

with 23 percent during the 1975 and 1980 recessions.

Industrial Production

Industrial production edged down 0.1 percent in July, following

declines that averaged 0.6 percent in the previous six months and that

have totaled about 10 percent since July 1981. Business equipment pro-

duction, one of the weakest sectors in recent months, dropped another

2.1 percent in July. Consumer goods output rose further, but this reflec-

ted mainly an increase in auto output. Assemblies were at an annual rate

of 6.6 million units in July, well above the sales pace for a second

month; as a result, the industry has scheduled a sharp reduction in

August assembly schedules to a 5.5 million unit rate.

Over the past year business equipment output has declined about 18

percent--substantially more than in the two preceding recessions. The

sharpest cutbacks have occurred in building and mining equipment, reflec-

ting extraordinary curtailments in oil-well drilling activity over the

past seven months. Office and computing equipment, a source of relative

strength in 1981 and early 1982, has been declining since March.

II-4

INDUSTRIAL PRODUCTION(Average monthly changes; percent)

1981 1982January to July to January to

June December June July

Total .3 -1.0 -.6 -.1

Consumer goods .4 -.9 .2 .6

Autos 2.6 -6.0 5.1 12.5Other .3 -.6 0 -.1

Equipment .5 -.1 -1.6 -1.2

Business .6 -.4 -2.2 -2.1Defense and Space .1 .9 .2 .8

Construction Supplies -.2 -1.9 -.8 .2

Materials .2 -1.6 -.6 .0

EQUIPMENT OUTPUT

Proportion Percent changeof totalequipment Average Sept. 1974 to July 1981 toJune 1982 recession1 Mar. 1975 July 1982

Business Equipment 71 -12.8 -14.2 -17.7

Building & Mining 11 -9.5 0 -32.4Manufacturing 15 -15.0 -15.0 -20.2Power 7 -6.3 -11.4 -15.6

Commercial 28 -10.3 -19.0 -9.4Transit 8 -25.2 -20.5 -14.62Farm 2 5.2 -4.7 -30.23

Defense and Space 29 -6.8 -4.2 6.2

1.May2.3.

Defined in terms of cyclical movements of total IP: Aug. 1957-Apr. 1958,1960-Feb. 1961, Oct. 1969-Nov. 1970, Sept. 1974-Mar. 1975.-29.0 percent since July 1979.-45.4 percent since July 1979.

II-5

Production of manufacturing equipment, which includes items such as metal-

working and general industrial equipment, has dropped about 20 percent

over the last year--about in line with other postwar recessions.

Capacity utilization in manufacturing edged downward in July to about

69-1/2 percent. Utilization has fallen more than 10 percentage points

during the last year and is now close to its March 1975 low. The amount

of slack is especially great among producers of industrial materials.

Personal Income and Consumer Spending

Mainly because of the estimated $25 billion cut in tax withholding

and an $11 billion Social Security cost-of-living adjustment, disposable

personal income rose at a hefty $44-3/4 billion annual rate in July.

Wages and salaries, which account for most of the cyclical variation in

income, increased $7 billion--only slightly faster than the monthly average

rise in the first half of the year.

Consumer spending in July did not appear to show much response to

the July tax cut. Retail sales increased 1 percent, recovering only part

of a 3.3 percent June plunge. Excluding sales at automotive outlets and

those with mainly nonconsumer items, spending in July increased 1/2 per-

cent, and was slightly above the second-quarter average. Apparel and

general merchandise stores performed better than average in July, but

furniture and appliance sales were down.

Auto sales were a major factor in the swings in consumer spending

in both June and July. Unit sales of domestic cars fell sharply in June

to 4.8 million units a year, the lowest selling pace yet during the

recession, and they recovered slightly to only a 5.1 million unit rate in

July. General Motors started a new dealer incentive program in the last

II-6

PERSONAL INCOME

1980 1981 1981 1982Q4 Q1 Q2 May June July

- - - - Percentage changes at annual rates1 - - - -

Total personal incomeWage and salary

disbursementsPrivate

Disposable personal incomeNominalReal

11.1 10.4

9.9 8.4 5.19.6 8.7 3.4

11.0 10.4 8.3.6 2.6 1.2

2.6 7.0 10.2 4.6 11.7

2.8 3.9 10.7 1.6 5.52.1 3.7 12.1 .9 3.4

3.0 7.3 4.2 2.4-1.8 3.6 .7 -8.4

24.8n.a.

- - - - - Changes in billions of dollars2 - - - - -

Total personal income

Wage and salary disburse-mentsPrivateManufacturing

Other incomeTransfer payments

Less: Personal contributionsfor social insurance

Memorandum:Personal saving rate

19.2 17.9

10.88.52.4

6.3

8.8 2.87.1 .41.1 -2.8

9.1 10.3 3.74.3 2.9 2.4

.7 1.2

7.0 16.2 21.6 9.9 25.1

4.0 6.6 13.82.7 5.4 12.6-.2 .9 2.5

2.1 7.0.9 3.6.4 -. 5

4.2 10.0 8.6 7.9 18.61.3 3.3 1.2 2.2 12.8

.2 1.3

5.8 6.4 7.5

.4 .8 .1 .7

6.6 6.9 6.4 7.2 8.1

1. Changes over periods longer than one quarter are measured from final quarterof preceding period to final quarter of period indicated. Changes for quarterlyperiods are compounded rates of change; monthly changes are not compounded.2. Average monthly changes are from the final month of the preceding periodto the final month of period indicated; monthly figures are changes from thepreceding month.n.a.-not available

II-7

part of July, and Ford followed suit in August, but sales in the first

ten days of August edged up only slightly further to a 5.3 million unit

annual rate.

Business Fixed Investment

Real outlays for producers' durable equipment fell at an 8-1/2 per-

cent annual rate in the second quarter, as business purchases of motor

vehicles weakened and spending was cut back for nonelectrical machinery.

In contrast to equipment outlays, investment in structures edged up in

the second quarter, reflecting continued increases in commercial and

industrial building activity, and a reported rise in oil- and gas-well

drilling. However, the data for energy drilling reported in the national

income accounts tend to lag new activity, and the second quarter gain

reflects earlier strength. More recently, the number of rotary rigs in

operation, a series that leads reported drilling by about six months,

has been falling sharply.

Advance indicators of business fixed investment suggest further

weakness in the capital goods sector in the months ahead. Orders for

nondefense capital goods, which have been below shipments for 11 of the

past 12 months, fell further in June to a level 15 percent below shipments,

and there are indications that the strength in commercial building activity

is waning. Vacancy rates for commercial office space have risen to 7 per-

cent from 4 percent in 1980. Although this is well below the level that

accompanied the collapse in commercial building in the mid-1970s, it does

suggest that there is diminishing incentive to undertake new commercial

building projects.

II-8

RETAIL SALES(Percent change from preceding period except where indicated;

based on seasonally adjusted data)

1981 1982 1982 1982Q4 Q1 Q2 July/Q2 May June July

Total sales -1.3 .1 2.7 -.3 2.9 -3.3 1.0

(Real)1 -2.4 -.7 2.1 ... 2.4 -4.6 ...

Total, less autos andnonconsumption items .4 .2 .7 .4 1.7 -1.1 .5

Total, exc. auto group,gasoline, and nonconsump-tion items .4 .5 1.5 .3 1.7 -1.3 .6

GAF2 -.1 -.3 1.4 .2 3.9 -3.5 1.3

Durable goods -5.6 .0 7.0 -2.3 5.1 -7.9 1.6Automotive -7.3 .2 11.4 -3.6 7.4 -11.4 2.2Furniture &appliances -.8 -4.7 2.2 -2.8 .5 -3.1 -.9

Nondurable goods .7 .2 .8 .6 1.8 -1.0 .7Apparel -.9 4.3 -1.3 1.5 5.4 -4.0 2.6Food 1.7 -.2 1.9 -.7 2.1 -1.9 .0General merchandise 3 .5 -.5 2.2 .8 4.5 -3.4 1.6Gasoline .4 -2.1 -5.3 .6 1.4 .3 -.1

1. BCD series 59. Data are available approximately 3 weeks following theretail sales release.

2. General merchandise, apparel, and furniture and appliance stores.3. General merchandise excludes mail-order nonstores; mail-order sales are

also excluded in the GAF composite sales summary.

AUTO SALES(Millions of units; seasonally adjusted annual rates)

1982 1982Ql Q2 Apr. May June July

Total 8.1 7.5 7.3 8.4 6.9 7.3

Foreign-made 2.2 2.0 1.8 2.0 2.2 2.2

U.S.-made 5.9 5.5 5.5 6.4 4.8 5.1

Small 3.0 2.5 2.4 2.9 2.2 2.4

Intermediate& standard 2.8 3.0 3.0 3.5 2.6 2.7

Note: Components may not add to totals due to rounding.

II-9

BUSINESS CAPITAL SPENDING INDICATORS(Percentage change from preceding comparable period;

based on seasonally adjusted data)

1981 1982 1982Q4 Q1 Q2 Apr. May June July

Nondefense capital goodsshipmentsCurrent dollars -.4 -5.6 -3.3 -6.1 3.9 -3.0 n.a.

Addendum: Sales of heavy-weight trucks (thousands) 201 217 173 170 187 162 158

Nonresidential constructionCurrent dollars .5 1.7 1.7 -.6 .7 4.2 n.a.

Addendum: Oil and gas welldrilling (millions of feet) 34.9 34.9 40.8 42.8 42.4 37.1 n.a.

BUSINESS CAPITAL SPENDING COMMITMENTS(Percentage change from preceding comparable period;

based on seasonally adjusted data)

1981 1982 1982Q4 Q1 Q2 Apr. May June

Nondefense capital goodsorders

Current dollars -6.5 -5.2 -4.9 2.0 -10.1 -5.2

MachineryCurrent dollars -2.7 -10.7 -4.2 3.5 -4.5 -10.1

Addenda: Ratio ofcurrent dollar unfilledorders to shipmentsTotal 5.84 5.94 5.86 6.24 5.87 5.90Machinery 4.37 4.30 4.26 4.54 4.34 4.30

Nonresidentialbuilding contracts

Current dollars -16.9 5.9 -14.9 -27.3 14.9 -27.6

I-10

VACANCY RATES FOR COMMERCIAL OFFICE SPACE

Vacant space as percent of total space available

S13

-4 9

-4 5

I I I I I I I I I I I I1970

Source:

1972 1974 1976 1978

Building Owners & Managers Association

1980 1982

-q 7

II-11

Housing

New residential construction pursued its zigzag recovery through the

early summer. Total private housing starts jumped by a record 34 percent

in July to a 1.2 million unit annual rate; this rise more than reversed

the decline registered the previous month. Both starts and building per-

mits last month were well above their second-quarter average, extending

the gradual upswing that developed during the first half of the year.

From the cyclical lows of late last year housing starts had risen 11 per-

cent by the second quarter of 1982, and newly-issued permits were up 21

percent. These increases were less robust--and less broadly based by

region and type of structure--than typical during the first two quarters

of recent housing upswings.

The upsurge in house sales that usually provides the basis for in-

creased single-family starts has yet to materialize. After rising a bit

late last year, sales of new units in the second quarter of 1982 dropped

to the lowest quarterly pace since data collection began in 1963. The

market for existing houses has shown no sign of a recovery, and sales

have remained below the 2 million unit rate since last fall.

Average prices of both new and existing houses sold in June were

only 3 percent above a year earlier, even though many reported sales

prices may be overstated because they incorporate premiums for "con-

cessionary" seller financing. The rise in measured house prices has

decelerated in a period when the advance in construction costs has slowed

to 5 percent during the last four quarters from the 9 and 11 percent

recorded in the previous two years.

II-12

PRIVATE HOUSING ACTIVITY(Seasonally adjusted annual rates, millions of units)

1981 1982

Annual Q4 Q1 Q2 May June July

All unitsPermits 0.99 0.76 0.82 0.92 0.94 0.93 1.10Starts 1.08 0.87 0.92 0.95 1.07 0.91 1.21

Single-family unitsPermits 0.56 0.42 0.45 0.49 0.49 0.52 0.50Starts 0.71 0.54 0.59 0.60 0.63 0.62 0.61

SalesNew homes 0.44 0.40 0.39 0.36 0.40 0.34 n.a.Existing homes 2.35 1.92 1.93 1.92 1.90 1.95 n.a.

Multifamily unitsPermits 0.42 0.34 0.37 0.43 0.46 0.41 0.60Starts 0.38 0.33 0.33 0.35 0.44 0.29 0.60

Mobile home shipments 0.24 0.21 0.24 0.25 0.25 0.26 n.a.

1. Preliminary estimates.n.a. Not available.

II-13

Multifamily housing starts more than doubled in July, after registering

the highest level in a year during the second quarter. Ownership units in

multifamily structures (condominiums and co-ops) have fared relatively well

in current markets. These units currently account for around two-fifths of

multifamily starts. Part of the recent strength in this sector is apparently

due to the increase in starts under the HUD section 8 program, which provides

rental subsidies for low-income projects. During the May to July period,

HUD reported such activity to be about double the depressed volume in the

same months of 1981. New construction under this program is being terminated

at the end of the current fiscal year, and many projects left "in the pipe-

line" will be started in the next few months.

Inventory Investment

While sharp production cutbacks have resulted in a liquidation of

most of the inventories accumulated in the second half of last year, the

rate of stock runoff slowed during the second quarter, contributing to

the rise in GNP. Moreover, with sales quite weak, stock-sales ratios in

the aggregate are still quite high. In constant dollar terms, the manu-

facturing and trade inventory-sales ratio for June was 1.74--about half-

way between the January peak of 1.80 and the prerecession level of 1.67.

Progress toward correction of inventory imbalances has been uneven.

Nondurable stocks seem to be more in line with sales than durable stocks.

Although most manufacturers have been successful in paring their stocks

through sharp production cutbacks, shipments in a few heavy industries,

particularly primary metals and nonelectrical machinery, have been so

weak that these industries have been unable to improve their positions

significantly.

II-14

PRIVATE HOUSING STARTS

Millions of units-- 2.0

Total

July

I/

Multifamily

Q2

a a I I I I

1.6

1.2

.8

.4

0

HOUSING SALES; NEW AND EXISTINGMillions of units

1980 1981

5.0

4..0

3.0

2.0

I I I I

m

19821979

II-15

CHANGES IN MANUFACTURING AND TRADE INVENTORIES(Billions of dollars at annual rates)

1981 19821979 1980 Q4 Q1 Q2 Apr. May (r) June (p)

Book Value Basis

Total 47.0 38.4 18.5 -29.0 -3.0 25.4 -54.3 19.9Manufacturing 30.4 23.0 3.8 -12.3 -19.8 -13.0 -30.4 -16.0

Durable 22.6 14.1 3.0 -9.5 -7.0 -1.8 -12.6 -6.6Nondurable 7.8 8.9 .8 -2.9 -12.8 -11.2 -17.9 -9.4

Wholesale Trade 10.0 10.6 9.5 -7.2 12.6 40.2 -14.2 11.6Retail Trade 6.7 4.9 5.3 -9.4 4.2 -1.9 -9.7 24.2

Constant Dollar Basis

Total 4.8 -1.7 1.7 -15.5 --- 10.4 -19.1 ---Manufacturing 5.2 .9 -3.6 -8.1 --- -5.3 -6.6Wholesale Trade .9 5 4.8 -3.4 ---- 14.9 -9.8 ---Retail Trade -1.3 -3.0 .6 -4.0 --- .8 -2.7 ---

INVENTORIES RELATIVE TO SALES 1

1974 1980Cyclical Cyclical 1981 1982

Peak2 Peak2 Q4 Q1 Q2 Apr. May (r) June (p)

Book Value Basis

Total 1.64 1.52 1.51 1.51 1.49 1.52 1.46 1.49Manufacturing 1.95 1.76 1.75 1.79 1.73 1.79 1.72 1.71

Durable 2.51 2.35 2.35 2.41 2.35 2.41 2.33 2.34Nondurable 1.39 1.18 1.16 1.18 1.12 1.18 1.13 1.11

Wholesale Trade 1.24 1.19 1.16 1.14 1.17 1.19 1.14 1.17Retail Trade 1.57 1.46 1.45 1.42 1.40 1.40 1.35 1.42

Constant Dollar Basis

Total 1.76 1.76 1.76 1.76 -- 1.77 1.72 --Manufacturing 2.18 2.11 2.12 2.15 --- 2.16 2.11 ---Wholesale Trade 1.40 1.47 1.45 1.43 --- 1.46 1.39Retail Trade 1.52 1.45 1.47 1.46 --- 1.45 1.41

Ratio of end-of-period inventories toHighs are specific to each series andRevised estimates.Preliminary estimates.

average monthly sales for the period.are not necessarily coincident.

II-16

As sales fell in June, retailers increased their book-value inven-

tories, returning their stocks to January levels after five consecutive

monthly declines. The June buildup was largely in autos, but most non-

auto stocks rose, particularly those at general merchandise stores.

As a result, retailers' inventory position deteriorated. The inventory-

sales ratio for retailers trade jumped to 1.42 at the end of June--not a

great deal better than its January peak of 1.46.

Wholesalers' mid-year inventories still appear to be burdensome.

By May, merchant wholesalers had liquidated only about one quarter of the

stocks they accumulated since the recession began, and book value data

for June show further worsening in their inventory position--a sizable

book-value increase accompanied by declining sales.

Federal Government

The tax cut and spending legislation that was passed last year, the

effects of the recession, and a sharp drop in spending for agriculture

price support programs by the Commodity Credit Corporation (CCC) combined

in the second quarter to hold down the increase of both federal receipts

and expenditures measured on an NIPA basis. The federal deficit declined

slightly to $116 billion at an annual rate as expenditures increased more

slowly than receipts.

Aside from the swings in CCC, outlays continued their recent upward

trend in the second quarter. Most nondefense purchases and grant programs

remain restrained by last year's budget cuts, but increased unemployment

outlays and a cost-of-living adjustment in Civil Service pensions helped

boost total spending in the second quarter. Interest outlays also in-

creased due to a higher average effective interest rate and growth of the

national debt.

II-17

On the receipts side of the budget, revenues were constrained by

low nominal income growth and by the provision of last year's Economic

Recovery Tax Act (ERTA). The accelerated cost recovery provisions of

the bill as well as declining corporate profits have contributed to de-

clines in corporate profits tax accruals. Receipts from personal taxes

have remained about unchanged as some cuts in nonwithheld income tax pay-

ments offset slower income growth.

The second stage of the withholding reductions that implement the

personal income tax cut portion of ERTA went into effect on July 1.

Although the legislation specified a 10 percent reduction in liabilities,

calculations based on the new withholding tables suggest that the cut in

withholding was only about 8.5 percent. However, this smaller-than-

specified cut should not result in larger refunds next April since the

withholding reductions that implemented the first stage of the tax cut

on October 1, 1981, were too large--about 5.8 percent instead of the 5.0

percent specified in ERTA. For the year as a whole, withholding should

be about as contemplated in ERTA, and the tax tables that individuals

will use to compute their 1982 returns show a full 10 percent cut.

The administration released its Mid-Session Review of the 1983 budget

in late July. The Review assumes implementation of the aggregate deficit-

reducing measures in the congressional First Budget Resolution and projects

deficits of $109 billion for FY 1982 and $115 billion for FY 1983. Action

on two bills that implement the tax increases and a part of the outlay

reductions assumed in the First Budget Resolution has been completed by

House-Senate conferences, and votes on these bills are expected in both

II-18

RECENT CHANGES IN CONSUMER PRICES 1

(Percentage change at annual rates; based on seasonally adjusted data) 2

Relativeimportance 1981Dec. 1981 1980 1981 Q1 Q2 May June

All items 100.0 12.4 8.9 1.0 9.3 11.4 12.6Food 16.6 10.2 4.3 3.9 7.3 10.2 7.6Energy3 11.1 18.1 11.9 -8.0 12.9 19.4 49.2Homeownership 26.1 16.5 10.1 -2.4 19.8 22.0 16.9All items less food,energy, homeownership4 49.8 9.9 9.4 5.4 6.9 4.4 8.3Used cars 3.3 18.3 20.3 5.5 3.5 1.2 2.5Other commodities4 19.9 8.1 6.1 4.8 3.7 2.9 4.6Other services4 26.6 10.3 10.6 6.3 8.0 7.7 7.2

Memorandum:Experimental CPI4 100.0 10.8 8.5 2.7 5.8 7.0 12.0

1. Based on index for all urban consumers.2. Changes are from final month of preceding period to final month ofperiod indicated; monthly changes at simple annual rates.3. Include home maintenance and repairs items of homeownership costs.4. BLS experimental index for "All items"-CPI-U-X1--which uses a rentsubstitution measure for homeownership costs.

RECENT CHANGES IN PRODUCER PRICES(Percentage change at annual rates; based on seasonally adjusted data)1

Relativeimportance 1982Dec. 1981 1980 1981 Q1 Q2 June July

Finished goods 100.0 11.8 7.1 .9 4.1 12.6 6.9Consumer food 21.9 7.5 1.4 6.1 11.5 5.5 -17.7Consumer energy 12.7 27.8 14.1 -18.5 -15.7 49.1 69.0Other consumer goods 44.6 10.4 7.1 3.9 5.3 8.3 3.6Capital equipment 20.8 11.4 9.2 2.4 6.2 9.5 5.6

Intermediate materials2 94.7 12.4 7.4 -1.8 -1.4 3.8 6.1Exc. energy 77.6 10.1 6.6 .1 .4 -1.7 -1.2

Crude MaterialsFood 50.7 8.6 -14.0 23.3 24.3 -7.8 -32.7Energy 33.6 26.9 22.8 -5.8 2.0 12.1 11.5Other 15.7 7.5 -11.4 -40.3 24.9 -4.0 12.6

1. Changes are from final month of preceding period to final month ofperiod indicated; monthly changes at simple annual rates.2. Excludes materials for food manufacturing and animal feeds.

II-19

houses later this week. A summary of these bills and of recent budget

actions leading to the Mid-Session Review is included in appendix II-A.

State and Local Government

Outlays by state and local governments continue to be weak. Pre-

liminary second quarter data show real purchases virtually unchanged

after falling at an annual rate of 1 percent in the first quarter. Contruc-

tion activity continued to drop; in real terms the cumulative decline

in new construction from January to June has been 5.1 percent.

Budget problems are still plaguing a number of states despite re-

trenchment on the spending side and numerous tax and fee increases.

Although only a few states actually expect to end fiscal year 1982 with

a deficit, reserves have declined from 4.5 percent of expenditures in

fiscal year 1981 to an estimated 1.5 percent in fiscal year 1982, according

to a survey by the National Governors Association and the National Associa-

tion of State Budget Officers. Generally, a reserve of 5 percent is con-

sidered to be a safe margin. Partly as a result of budget-balancing

measures, state and local personal taxes increased at a 6.6 percent annual

rate in the second quarter and indirect business taxes rose at a 12.2

percent annual rate.

Prices

Despite increases in the CPI of 1 percent in each of the past two

months, this year's moderation in inflation continues to be fairly broad-

based. The rapid rise in consumer prices in May and June reflected a

sharp bounceback in gasoline prices and very large increases in the CPI

measure of house prices. Excluding the volatile food, energy, and home-

ownership figures, inflation in the consumer sector since December was the

II-20

lowest half-year rate in more than four years. At the producer level,

price increases for investment goods also have slowed dramatically in

the face of deteriorating sales in the capital goods industries. More-

over, a decline in materials costs during the first half of 1982, along

with sharply reduced labor cost increases, promises further improvement

in the inflation picture.

Homeownership costs continued to boost the official CPI in June,

but the home price index has become increasingly unreliable. The CPI

home price index rose 12 percent at an annual rate in the first half of

1982, far more than the 3 percent rise indicated by more comprehensive

measures. The CPI mortgage interest rate index has remained near an

implied level of 15 percent for several months.

Food price increases in May and June were larger than in the two

preceding months, owning mainly to sharp advances in retail meat prices;

but inflation rates remained very low for consumer foods other than

meats. The spurt in meat prices appears to have lost some of its

momentum around mid-year as cattle prices plummeted in the July PPI,

while hog prices also turned down. In addition, at the farm level, grain

and soybean prices have tumbled as prospects for another good harvest

have become more certain. If maintained, declines in crop prices will

help contain cost pressures in the food sector in the coming year, but

they are also cutting deeply into farm proprietors' profits.

Retail gasoline prices increased more than 5 percent in June, but

recent surveys indicate they have since been relatively stable. Further-

more, spot prices of petroleum appear to have remained steady at levels

below the official OPEC prices.

II-21

SELECTED MEASURES OF COMPENSATION, PRODUCTIVITY,AND COSTS IN THE NONFARM BUSINESS SECTOR

(Seasonally adjusted annual rates)

1981 1982 Year-to-1980 1981 Q3 Q4 Q1 Q2 date

Hourly Earnings Index - production workers1Dec. 1981-July 1982

Total private nonfarm

ManufacturingContract constructionTransportation and

public utilitiesTradeServices

9.6 8.4

10.9 8.87.7 8.1

9.3 8.58.8 7.19.5 9.1

Employment Cost Index, wages and salaries -

TotalBy Occupation:White collarBlue collarService Workers

By Bargaining Status:UnionNonunion

9.0 8.8

8.7 9.19.6 8.68.1 8.3

10.9 9.68.0 8.5

8.5 7.3

8.7 7.78.9 8.8

6.4 7.78.0 4.39.3 9.2

all persons2

8.4 7.7

7.5 9.19.3 6.98.5 6.5

10.4 8.97.7 7.7

6.5 6.3

8.7 6.79.0 2.4

7.4 5.93.8 6.35.1 7.4

1981-Q4 to1982-Q1

n.a.

7.2 n.a.6.4 n.a.7.9 n.a.

7.16.5

n.a.n.a.

1981-Q4 to1982-Q2Labor Productivity and Costs - all persons1

Compensation per hourOutput per hourUnit labor costs

10.6 8.8.3 -.1

10.2 8.9

9.0 7.3-.3 -3.59.3 11.2

1. Changes over periods longer than one quarter are measured from final quarter ofpreceding period to final quarter of period indicated. Quarterly changes are at compoundrates; monthly changes are not compounded.2. Percent change from final month of previous period, compounded. Seasonal adjustmentby FRB staff.

6.2

7.54.7

4.44.37.4

7.2

7.26.47.9

7.16.5

10.12.67.4

8.02.45.6

II-22

Wages and Productivity

A broad range of measures indicate a continued deceleration in

wages during 1982-H1 in response to unemployment rates that have now

exceeded 7 percent for more than two years, as well as to the drop in

inflation. The rate of increase in the hourly earnings index, which

had slowed more than 1 percentage point during 1981, has decelerated

a further 2 percentage points to a 6.2 percent rate so far this year.

While this measure only covers the wages of production workers, the

latest quarter's data from the employment cost index show that the slow-

ing also has occurred in salary rates for white collar workers. The

broadest measure of labor costs, hourly compensation, which covers both

wages and fringes, is now rising about 1 percentage point slower than

last year.

Wage concessions, defined as any agreement significantly less than

traditional wage-setting practices, are one part of this slowing. These

concessions have now affected more than 10 percent of the unionized work-

force. While scheduled adjustments have continued to boost union wages

by more than 4 percent a year, the contribution of both new settlements

and COLAs has declined dramatically. Halfway through a heavy bargaining

year, increases in wage rates provided by new settlements have averaged

only 2.7 percent over the life of the contract (excluding COLAs); this

compares with the 7.7 percent increases these same parties received when

they last bargained almost three years ago.

A cyclical productivity rebound in the first half of 1982 also has

eased the pressure of higher compensation costs on prices. Output per

II-23

NEGOTIATED WAGE-RATE CHANGESUNDER MAJOR COLLECTIVE BARGAINING SETTLEMENTS1

(Percent change)

Same partiesas during 1982 1982under prior First

1980 1981 settlements 6 months

All IndustriesFirst-year adjustments 9.5 9.8 7.7 3.0Average over life of contract 7.1 7.9 6.0 2.7

Workers affected (in thousands) 3787 2295 --- 1885

Contracts with escalator provisionsFirst-year adjustments 8.0 8.2 n.a. 1.4Average over life of contract 5.0 5.5 n.a. 1.2

Workers affected (in thousands) 2268 612 -- 1369

Contracts without escalator provisionsFirst-year adjustments 11.7 10.8 n.a. 7.2Average over life of contract 10.3 9.1 n.a. 6.8

Workers affected (in thousands) 1489 1683 --- 516

1. Contracts covering 1,000 or more workers; estimates exclude potential gainsunder cost-of-living clauses.

EFFECTIVE WAGE CHANGE IN

MAJOR UNION CONTRACTS

Contribution of:COLANew SettlementsPrior Settlements

F"" ssg*4

1978 1979 19801976 1977 1981 1982 HI1

n

II-24

hour grew 2-1/2 percent in both the first and second quarters. A surge

in productivity growth is common during the latter stage of a recession

when output stabilizes while employers continue to cut labor input in

lagged response to earlier output declines.

Appendix II-A

THE FEDERAL BUDGET AT MID-SESSION

The Administration released its Mid-Session Review of the budget,required by the Budget Act of 1974, late in July. This review updated

its February budget to take into account actual economic developments

thus far in the current year, and to incorporate minor program revisionsand technical re-estimates. For 1983, the economic assumptions that

underlie the budget estimates were revised to reflect the rates of

growth of nominal and real income and the interest rates assumed bythe Congress in its First Concurrent Resolution on the budget. The

budget totals (but not individual components) also were adjusted toreflect the aggregate amount of deficit-reducing measures in the Con-

gressional budget resolution, as these involved both slightly largerspending reductions and larger revenue raising measures than were

assumed in the Administration's original 1983 budget proposals. Table 1

compares the deficit-reducing measures in the Administration's Februarybudget and in the Congressional resolution.

At about the same time that the Administration released its Mid-Session Review, the Director of the Congressional Budget Office (CBO)

indicated in testimony that a preliminary review by CBO of the economicoutlook and budget prospects suggested that federal budget deficits in

fiscal years 1982 and 1983 would exceed those in the Congressional reso-lution. Tables 2 and 3 show that a major element in the upward revi-

sions in the estimates of the deficits for these two years, by both theAdministration and CBO, has been a weaker economic outlook; forecasts

of inflation have also been lowered somewhat.

In the Mid-Session Review, the Administration emphasized that it

attached high priority to the achievement of the deficit-reducing mea-

sures contained in the Congressional budget resolution. Since the

Mid-Session review was released, House-Senate Conference committee

action has been completed on two bills that implement parts of these

measures; votes on these bills are expected in both houses of the

Congress this week. One of these bills contains the revenue-raising

measures and the reductions in entitlements under the jurisdiction of

the Senate Finance and House Ways and Means committees. This bill is

reported to contain provisions that reduce spending for entitlement

programs by a cumulative amount of $15.2 billion (principally medicare

and medicaid) over three years. (It would also raise outlays by

liberalizing extended unemployment compensation in high-unemployment

states.) Revenues are reported to be raised by a cumulative total of

$98.3 billion over the same period. The revenue-raising provisions do

not change the reductions in personal income tax rates enacted last

year but do scale back some of the business depreciation, investment

tax credit, and leasing provisions in the Economic Recovery Tax Act

(ERTA) of 1981.

Under the provisions of the revenue-raising bill:

o Individual income tax provisions would be tightened by-- limitations on deductions for medical expenses and

insurance and uninsured casualty losses-- an expanded alternative minimum tax (the add-on mini-

mum tax would be eliminated)-- limits on contributions and benefits available under

pension plans

o Excise taxes would be increased by raising the cigarette taxfrom 8 to 16 cents a pack, raising the tax on telephone ser-vices from 1 to 3 cents for 1983-85 (after which, it wouldbe removed), and raising the airline ticket tax from 5 to 8percent (plus increases in other taxes related to air travel).

o Corporate taxes would be raised by-- reducing the depreciable value of investments by half

the amount of the investment tax credit (or reducing theamount of the credit utilized) and cancelling the furtheracceleration of depreciation scheduled to takeplace in 1985 and 1986

-- limitations on leasing provisions in ERTA and expirationof the ERTA leasing provisions entirely for propertyplaced in service after 1983; conventional leasing ruleswould be liberalized after 1983

o Corporate tax revenues would also be raised by tighteningspecialized provisions including-- reduction by 15 percent in the value of certain tax pre-

ferences, including percentage depletion for coal andiron ore, bad debt reserves, Domestic International

Sales Corporations, pollution control facilities, andinterest on debts used by financial institutions tocarry tax-exempt securities acquired after 1982

-- tighter limitations on the use of industrial developmentbonds and disallowance of "small-issue" industrial develop-ment bond use after 1985

-- tighter provisions pertaining to mergers and acquisitions;-- a requirement that businesses capitalize construction

period interest and taxes for nonresidential property;-- restrictions on the deferral of taxes on income from

longer-term contracts-- limitations on favorable tax treatment for life insurance

companies through use of co-insurance-- some reduction in the tax advantages to companies operat-

ing in Puerto Rico-- tightened treatment of original issue discount bonds

II-A-2

o Tax compliance would be increased by

-- imposing a withholding tax of 10 percent on interest anddividends; exceptions would be made for low income indi-viduals and most elderly and for interest of less than$150 per year from any single institution

-- stricter reporting of restaurant tips

-- acceleration of corporate tax payments within the yearwhen the liability is incurred

This bill also would extend the targeted jobs credit for hiring certain

hard to employ groups; the credit, which had been scheduled to expire,would apply to individuals who begin work before 1986.

The second bill that implements a portion of the outlay reductionscontained in the Congressional budget resolution would delay cost of

living increases for federal pensioners, limit price supports for farmproducts, and make further cuts in the foodstamp program. Extremely

preliminary estimates of the outlay reductions that would result from

this bill are reported to total about $13 billion over three years.

The remaining outlay reductions assumed in the Congressional

budget resolution are to be achieved by limiting annual appropriations

below current services levels, administrative management measures to

reduce costs and the lower estimates interest costs below baseline

assumptions as a result of smaller deficits to be financed and a

projected response of interest rates to the improved deficit outlook.

Congressional action on the appropriations bills is in a very early

stage.

II-A-3

Table 1

BUDGET REDUCTION INITIATIVES(unified budget; fiscal year; billions of dollars)

Defense (excluding pay and retirement)

Federal pay

Discretionary appropriated programs

Entitlements

Management initiatives

User fees (offsetting receipts)

Other

Subtotal

Interest

Total Outlay Reductions

Revenue Increases

TOTAL DEFICIT REDUCING MEASURES

1983Administration

1.4

11.5

12.8

13.4

1.2

40.3

2.7

43.0

12.8

55.8

II-A-4

Congress

7.8

5.1

5.9

6.6

13.7

1.1

1.2

41.4

14.5

55.9

20.9

76.8

Table 2

REVISIONS OF THE ADMINISTRATION'S BUDGET ESTIMATES(fiscal years, billions of dollars)

1982 1983

Outlays

February Estimate 725.3 757.6Technical re-estimates and minor

program changes1 +4.7 +10.5Economic assumptions

Unemployment compensation +0.7 +1.7

Net interest +0.2 -2.5Social security (lower inflation) -0.4 -1.0

Other +0.4 -0.7Subtotal, economic assumptions +0.9 -2.5

Adjustment for Budget Resolution 2 - -4.1Mid-Session Review Estimate 731.0 761.5

Receipts

February Estimate 626.8 666.1

Technical re-estimates and minorprogram changes +6.3 -0-

Economic assumptions -11.0 -27.6

Adjustment for Budget Resolution -- +8.1

Mid-Session Review Estimate 622.1 646.5

Deficit

February Estimate 98.5 91.5

Mid-Session Review Estimate 108.9 115.0

1. The largest component is upward revisions of Commodity Credit

Corporation outlays.2. Includes effect on interest outlays of larger deficit reducing

measures.

Note: Details do not add to totals due to rounding.

II-A-5

Table 3

CBO REVISIONS OF DEFICIT ESTIMATES

(fiscal years; billions of dollars)

1982 1983

Congressional Resolution target -105.7 -103.9

Technical re-estimates1 -8.1 -12.5

Economic assumptions2 - -25 to -35

Current CBO Deficit Estimate 3 -109 to -114 -141 to -151

1. Re-estimates by CBO of those parts of the Congressional budgetresolution not based on CBO estimating techniques. These re-estimatesdo not reflect new information received by CBO in conjunction with theAdministration's Mid-Session Review; that information is currentlybeing evaluated by CBO.2. Reflects a preliminary CBO forecast made in July and subject torevision and updating for subsequent data.3. The deficit range for 1982 reflects CBO's assessment of data availablethrough mid-June on actual receipts and outlays for the year to date.

II-A-6

III-T-1

SELECTED FINANCIAL MARKET QUOTATIONS1

(Percent)

1981 1982 Change from:Feb. FOMC Feb. FOMC

Highs Highs July 1 Aug. 17 Highs July 1Short-term rates

Federal funds2

Treasury bills3-month6-month

1-year

Commercial paper1-month3-month

Large negotiable CDs3

1-month3-month6-month

Eurodollar deposits 2

1-month3-month

Bank prime rateTreasury bill futures

Sept. 1982 contractMar. 1983 contract

Intermediate- and long-term rates

U.S. Treasury (constant3-year

10-year30-year

Municipal (Bond Buyer)

Corporate--Aaa utilityRecently offered

20.06

17.0115.9315.21

18.6318.29

18.9019.01

18.50

19.8019.56

21.50

14.46

14.20

maturity)16.5915.8415.20

13.30

17.72

15.61

14.5714.3613.55

15.7315.61

15.9416.1416.18

16.3616.53

17.00

14.18

14.02

15.1614.9514.80

13.44

16.34

14.81 10.28p

12.5512.9012.72

8.059.399.84

14.61 9.3814.61 9.88

14.8715.1615.29

9.8710.1611.00

15.66 10.8016.28 11.58

16.50 14.50

12.84 9.4013.03 11.20

14.6814.4013.90

12.2112.6512.42

12.58 11.864

16.00e 14.50p

S&L fixed-rate mort-gage commitment 18.63 17,66 16.735 16.445 -1.22 -.29

1981 1982 Percent change from:FOMC 1981 FOMC

Highs July 1 Aug. 17 Highs July 1Stock Prices

Dow-Jones Industrial 1,024.05 803.27 831.24 -19.8 +3.5

NYSE Composite 79.14 62.51 62.41 -21.1 -.2

AMEX Composite 380.36 249.40 244.30 -35.8 -2.0

NASDAO (OTC) 223.47 170.60 162.28 -27.4 -4.9

1. One-day quotes except as noted. 4. One-day quotes for preceding Thursday.

. Averages for statement week closest to date shown. 5. One-day quotes for preceding Friday.

. Secondary market. p--preliminary. e--estimated.

-5.33

-6.52-4.97-3.71

-6.35-5.73

-6.07-5.98-5.18

-5.56-4.95

-2.50

-4.78-2.82

-2.95-2.30-2.38

-1.58

-1.84

-4.53

-4.50-3.51-2.88

-5.23-4.73

-5.00-5.00-4.29

-4.86-4.70

-2.00

-3.44-1.83

-2.47-1.75-1.48

-. 72

-1.50

DOMESTIC FINANCIAL DEVELOPMENTS

M1 was unchanged during July, and moved within the upper bound of

its 1982 growth range for the first time. Although M2 and M3 continued

to exceed targeted levels, the weakness in transactions deposits resulted

in a substantial decline in adjustment borrowing at the discount window.

The System gave further impetus to an easing of money market conditions

through three one-half percentage point cuts in the discount rate.

Federal funds, which generally traded in the neighborhood of 14-3/4

percent at the time of the last FOMC meeting, most recently have been in

the 10 percent area. Other short-term market rates have declined 3 to 5

percentage points during the intermeeting period, reaching the lowest

levels since the summer of 1980. Taxable long-term bond rates have fallen

about 1-1/2 percentage points; about one-third of the decline occurred on

August 17. The term structure of rates has assumed an extraordinarily

sharp upward slope in the maturity range under two years, evidencing market

expectations that security yields will be rising considerably in the months

ahead.

One reason for this bearish outlook is the trajectory of the federal

budget. Treasury borrowing expanded sharply in July and early August in

order to help finance a record deficit for the third quarter and to build

up cash in anticipation of another massive fourth-quarter shortfall. State

and local governments, meanwhile, have continued to borrow heavily, mainly

in the form of revenue bonds. Nonfinancial business firms appear to have

continued raising funds in roughly the same volume as in the first half of

the year, with high bond rates remaining a deterrent to long-term financing.

Residential mortgage commitment and lending activity has remained quite

III-1

III-2

MONETARY AGGREGATES(Based on seasonally adjusted data unless otherwise noted) 1

1981 1982 QIV. '81to

Q4 Q1 Q2 May June July July '82

-Percentage change at annual rates--

Money stock measures1. M12. (M1)

2

3. M24. M3

Selected components5. Currency

6. Demand deposits

10.4 3.3 -2.49.5 3.6 0.89.8 9.5 10.78.7 10.7 10.9

4.3 7.9 9.3 10.5

-0.3 0.0 5.02.7 -3.7 4.76.6 9.3 9.69.0 12.5 10.3

9.4 3.7 8.2

-0.2 -0.5 -5.8 -2.1 -8.3 -2.1 -3.4

7. Other checkable deposits

8. M2 minus M1 (9+10+11+14)

9. Overnight RPs and Eurodollars, NSA3

10. General purpose and broker/dealermoney market mutual fund shares,NSA

11. Commercial banks12. savings deposits13. small time deposits14. Thrift institutions15. savings deposits16. small time deposits

1 minus M2 (18+21+22)

Large time depositsat commercial banks, net

4

at thrift institutionsInstitutions-only money marketmutual fund shares, NSA

Term RPs, NSA

27.6 49.5 19.6 -21.7

9.9 9.5 11.5 14.9

-44.1

74.210.3

-11.920.81.5

-11.76.6

11.2

3.50.2

19.5

63.6 -8.4 71.3

33.89.48.79.71.610.2-1.5

20.917.2

2.023.8

6.00.68.1

17.814.2-1.520.810.93.2

13.9

6.9 -1.4 26.2

8.7 12.2 11.0

8.4 8.4 25.5

31.49.9-4.515.82.4

-3.24.5

19.213.9

-21.828.510.0

-19.020.7

3.3 16.6 12.1 20.8 28.5

8.9 19.0 16.3 25.8 26.3 17.26.1 19.8 20.4 26.9 31.3 17.4

21.6 15.5 -4.1 20.5 4.0 16.4

132.8 -2.5 15.2 49.5 32.9 106.8 23.70.0 -29.9 3.7 -66.7 -48.3 -50.3 -22.0

-Average monthly change in billions of dollars-

MEMORANDA:23. Managed liabilities at commercial

banks4 (24+25)24. Large time deposits, gross

5

25. Nondeposit funds5

26. Net due to related foreigninstitutions, NSA5

27. Other5 ,6

28. U.S. government deposits at commercialbanks

7

0.2-0.20.4

-2.32.7

0.8

0.4 6.32.7 5.8

-2.3 0.5

-2.3 0.40.0 0.1

1.9 -2.5

10.9 6.48.3 10.72.6 -4.3

1.8 -4.60.8 0.3

1.7 -5.4 -1.4

1. Quarterly growth rates are computed on a quarterly average basis. Dollar amounts shown under memoranda forquarterly changes are calculated on an end-month-of-quarter basis.2. M1 seasonally adjusted using alternative model based procedure applied to weekly data.3. Overnight and continuing contract RPs issued to the nonbank public by commercial banks, net of amounts heldby money market mutual funds, plus overnight Eurodollar deposits issued by Caribbean branches of U.S. memberbanks to U.S. nonbank customers. Excludes retail RPs, which are in the small time deposit components.4. Net of large-denomination time deposits held by money market mutual funds and thrift institutions.5. Adjusted for shifts of assets and liabilities to International Banking Facilities (IBFs) which affectedflows from December 1981 to June 1982.6. Consists of borrowings from other than commercial banks in the form of federal funds purchased, securities

under agreements to repurchase and other liabilities for borrowed money (including borrowings from the1 Reserve and unaffiliated foreign banks), loans sold to affiliates, loan RPs and other minor items.

are partially estimated.7. Consists of Treasury demand deposits at commercial banks and Treasury note balances.

III-3

weak, while consumer installment credit has continued a pattern of slow

growth.

Although the shocks of recent business and financial institution

failures appear not to have significantly disrupted credit flows on a

macro level, financial markets have been marked by a considerable unease

and volatility. Lenders have exhibited some heightened quality conscious-

ness, and risk premiums have increased in several sectors--most dramati-

cally in the commercial paper market, where the rate spread between

medium- and highest-quality paper has become the widest since 1974. In

contrast to 1974, however, there has not been a general closing of the

commercial paper or bond markets to lower-rated borrowers, and on the whole

non-price rationing by lenders has been limited to a fairly selective cul-

ling of questionable credits.

Monetary Aggregates and Bank Credit

During July, M1 was unchanged on a monthly average basis, after two

months of slight decline.1 Outflows from demand deposits slowed in July,

but currency growth decelerated from the pace of previous months and OCDs

declined slightly. The recent behavior of M1, given the sharp drop in

short-term interest rates, suggests a continued unwinding of the bulge in

M1 demand that occurred during late 1981 and early 1982.

Concurrent with the weakening in OCDs, there has been a renewed run-

off in regular savings deposits. Passbook balances at all depository

1. The monetary aggregates table also includes an alternative seasonally

adjusted M1 now being published on an experimental basis. This alterna-

tive measure, which exhibits somewhat smoother month-to-month changes,

registered slower growth than the current M1 series in the first few

months of 1982. Since April, however, the alternative measure has

tended to grow more rapidly, despite a 3-3/4 percent rate of decline in

July.

III-4

institutions fell at an annual rate of more than 20 percent in July, the

first substantial outflow since last October. However, a sharp increase

in small-denomination time deposits during July more than offset the weak-

ness in savings balances and largely accounted for a pickup in the nontrans-

actions component of M2. As a result, M2 growth accelerated to a 9-1/4

percent annual rate in July--just a shade below the pace of the first half.1

The surge in small time deposits was evident at both commercial banks

and thrifts, but commercial banks gained a proportionately larger share,

likely owing to their relatively better performance with 6-month MMCs. Con-

cerns about the health of thrift institutions may have allowed banks to com-

pete more favorably for these accounts, on which there is no rate differen-

tial. General purpose and broker/dealer MMMF shares picked up sharply

towards the end of July and in early August, as their yields became attrac-

tive relative to more rapidly declining short-term market rates.

M3 growth accelerated to a 12-1/2 percent annual rate in July. In

addition to more rapid expansion in its M2 component, this increase reflec-

ted continued heavy sales of large CDs and sharply larger inflows into insti-

tution-only MMMFs. In July, rate spreads favored increased use by banks of

domestic CDs to fund assets booked at affiliated offices abroad. In addi-

tion, some institutions reported seeking CD funds as a precaution against

1. M2 velocity likely will fall again in the current quarter, marking thefourth consecutive quarterly decline. Substantial declines in M2 velo-city of the sort seen in the past year have occurred earlier in thepostwar era only during periods of reintermediation when interest ratesfell below Regulation Q ceilings; however, the present composition of M2suggests that this pattern may be much less important now. The emergenceof high real rates and the prevailing economic uncertainties may havecaused households to shift their portfolios toward financial assets ingeneral, and especially toward the relatively safe short-term assetsencompassed by M2.

III-5

possible liquidity problems in the wake of recent bank and security firm

failures.

A bulge in risk premiums that developed on CDs relative to Treasury

bills in late June and early July--around the time of the Penn Square fail-

ure--had largely disappeared prior to the Lombard-Wall bankruptcy announce-

ments on August 12 when it widened again, but only briefly.1 In recent

weeks liquidity problems have not required an unusual amount of discount

window use. Just a few of the thrift institutions that were uninsured

depositors in Penn Square have borrowed, and only Abilene National Bank,

which was merged with another bank on August 6 because of its own loan

problems, has required quantitatively significant assistance. Adjustment

plus seasonal borrowing has averaged about $400 million (daily average

basis) thus far in August, versus $1.1 billion in the month of June.

Bank credit grew at a 6-1/2 percent annual rate in July, slightly

faster than in June but below the pace of earlier months. The rise

involved a moderate increase in holdings of U.S. Treasury securities at

both large and small banks--with growth at large banks primarily in trad-

ing accounts--together with stepped up growth in consumer loans and the

first expansion in security loans since March. The increase in consumer

1. However, some of the specific banks that had large loan losses associ-ated with the Penn Square and Lombard-Wall failures reportedly still arefacing resistance in selling short-term liabilities, most notably Continen-tal Illinois and, more recently, Chase Manhattan. In recent weeks, second-ary market quotes on Continental's CDs have ranged from 50 to as much as170 basis points above CD rates paid by top tier banks. As alternativesto the CD market as a source of funds, Continental has tapped the Eurodollarand the federal funds markets, and has obtained money through its Edge Actsubsidiary. Rates on Chase's CDs reportedly have been as much as 40 to 50basis points above those of other top tier banks, in response to theirheavy issuance of CDs and also to reports of their losses related to thePenn Square and Lombard-Wall problems.

III-6COMMERCIAL BANK CREDIT AND SHORT- AND INTERMEDIATE-TERM BUSINESS CREDIT(Percentage changes at annual rates, based on seasonally adjusted data)

1

1vt I

Q4

1982

QI Q2 May June July

-Commercial Bank Credit--

QIV '81to

July '82

1. Total loans and investmentsat banks2 '3

2. Investments

3. Treasury securities

4. Other securities

5. Total loans2,3

6. Business loans2 ,3

7. Security loans

8. Real estate loans

9. Consumer loans

6.4

4.8

-7.8

11.2

6.9

9.2

58.6

7.3

4.1

10.1

5.7

11.5

2.8

11.5

16.8

-18.3

7.8

2.8

-Short- and

7.9 9.0 5.1 6.4 8.7

4.7 2.1 1.7 2.4 4.7

4.9 -3.1 -5.2 7.3 6.7

4.8 4.6 5.1 0.0 3.7

9.0 11.3 6.4 7.6 10.0

14.9 19.1 14.5 9.6 15.0

-26.8 -17.2 -64.1 92.3 1.4

6.6 6.5 7.3 .8 6.8

3.0 3.2 2.6 5.7 3.7

Intermediate-Term Business Credit--

10. Total short- and intermediate-term business credit (sum of

lines 14, 15 and 16)11. Business loans net of bankers

acceptances3

12. Commercial paper issued by non-financial firms5

13. Sum of line 11 & 12

14. Line 13 plus loans at foreignbranches6

15. Finance company loans to business

16. Total bankers acceptances outstanding7

13.8

9.3

21.3

10.8

14.0

7.6

20.9

15.2

16.5

30.0

18.2

18.5

1.0

11.7

13.1

15.8

16.8

15.9

15.7

1.5

10.2

18.5

19.9

33.1

21.7

23.1

-1.5

11.7

10.6

18.0

2.0

15.9

13.6

10.5

-6.6

n.a.

11.0

38.2

14.9

14.9

n.a.

n.a.

n.a.

15.5

27.7

17.0

17.4

n.a.

n.a.

1. Average of Wednesdays for domestically chartered banks and average of current and preceding ends of months forforeign-related institutions.2. Loans include outstanding amounts of loans reported as sold outright to a bank's own foreign branches, uncon-solidated nonbank affiliates of the bank, the bank's holding company (if not a bank), and unconsolidated nonbank

subsidiaries of the holding company.3. Adjusted for shifts of assets and liabilities to International Banking Facilities (IBFs) which effected flowsfrom December 1981 to June 1982.4. Growth of bank credit from the FOKC's December-January base through July 1982, not adjusted for shifts of assetifrom domestic offices to IBFs, was at an annual rate of 7.8 percent. Adjusted for such shifts after January, growtlover this period was 8.6 percent.5. Average of Wednesdays.6. Loans at foreign branches are loans made to U.S. firms by foreign branches of domestically chartered banks.7. Based on average of current and preceding ends of month.n.a.-not available.

____ __

III-7

loans was the largest since last December. In contrast, real estate loans

showed almost no growth, and the pace of business lending slowed.

Business Finance

Nonfinancial firms continued to raise a substantial amount of funds

in credit markets during July, with the monthly pace probably approximating

the average for the first half of the year. Most borrowing continued to be

concentrated in shorter maturities, but--as open market yields fell sharply

below the bank prime rate--there was a shift away from domestic banking

offices toward commercial paper and to a lesser degree foreign branches.

The prime rate has fallen from 16-1/2 to 14 percent; even so, it remains

at a large spread over commercial paper and CD rates.

Corporate bond issuance picked up somewhat in July; there are indi-

cations of another spurt currently in response to the recent market rally.

Public offerings reached almost $3 billion in July, on a seasonally adjusted

basis. Most of this volume comprised issues by industrial and financial

concerns, and $1.1 billion of it was in the form of extendable notes.1

Much of the conventional longer maturity bond financing was undertaken by

electric utilities. Although the monthly volume of Eurobond offerings by

U.S. corporations in June and July was substantially less than during ear-

lier months in 1982, the pace of such financings appears to have quickened

in recent weeks.

Stock prices declined in July and early August, but a large portion

of this drop was offset by the spectacular August 17 market rally. Despite

1. The interest rate on an extendable note is reset periodically--most com-monly every 1 to 3 years--and investors have a put option on those occasions.If the maturities of such notes are categorized by the length of the exten-sion intervals, then about two-thirds of public bond issues in July hadmaturities of less than five years.

III-8

GROSS OFFERINGS OF SECURITIES BY U.S. CORPORATIONS(Monthly totals or monthly averages, millions of dollars)

1981 1982

P PYear 1qi 2 June July

------------Seasonally adjusted----------

Corporate securities--total

Securities sold in U.S.Publicly offered bondsPrivately placed bondsStocks

Securities sold abroad1

6,347

5,8333,138

5822,113

514

6,135 5,998 2,702 5,594

4,7232,088

7251,910

4,6212,062

3332,226

1,412 1,377

2,509778514

1,217

193

5,2952,954

6441,697

299

--Domestic offerings, not seasonally adjusted--

Publicly offered bonds--total2

By industryUtilityIndustrialFinancial

By quality3

Aaa and AaA and BaaLess than BaaNo rating

Memo items:Convertible bondsOriginal discount bonds

Par valueGross proceeds

Stocks--totalBy industry

UtilityIndustrialFinancial

3,138

1,0791,192867

1,1821,448

226282

2,113

6751,053

385

1,873 2,463 1,500 3,300

693464716

528928228189

935587941

9321,086

196249

790 750310 1,450400 1,100

505535260200

1,5001,300

135365

48 169 150 60

910 1,129 121 300297 394 99 103

1,865 2,105 1,500 1,500

642985238

972577556

330940230

500450550

p--preliminary.1. Notes and bonds, not seasonally adjusted.2. Total reflects gross proceeds rather than par

count bonds.value of original dis-

3. Bonds categorized according to Moody's bond ratings.

III-9

July's lower share prices, stock issuance rose last month on a seasonally

adjusted basis, mainly because of increased offerings by utilities and

financial concerns. Banks in particular have been making a considerable

effort to raise primary capital over recent months, and two large issues

of preferred bank stock accounted for a substantial share of the financial

stock offerings.

New stock issues related to the retirement of outstanding bonds--

transactions that reduce debt-equity ratios and that are known as debt-

equity swaps--averaged just under $300 million per month during the first

half of the year. Most of these transactions were undertaken by industrial

firms. Preliminary data for July indicate a considerable slowing in such

transactions, which became less attractive because of the rise in bond

prices and the general decline in stock prices then. Some other companies

have removed debt from their balance sheets by "defeasance"--effectively

offsetting the liabilities with binding commitments of cash or other assets.

Both of these methods permit firms to boost current reported earnings by

realizing a capital gain on their outstanding deeply discounted debt, but

the transactions produce a smaller tax liability than would be incurred by

a straight liquidation of debt.

Ouality rate spreads on corporate security yields have exhibited mixed

movements against a backdrop of numerous dividend reductions and omissions,

adverse rating actions, and business failures. The rate spread between

high- and medium-quality commercial paper has widened substantially since

the last FOMC meeting, reaching 163 basis points, but the quality spread

in corporate bond yields has not widened and lower-rated issuers still

appear to have access to the primary market.

III-10

TREASURY AND AGENCY FINANCING1

(Total for period; billions of dollars)

1982Q2 Q3 e June July e Aug. f

Treasury financing

Combined surplus/deficit(-)

Means of financing deficit:

(1) Net cash borrowingfrom the public

Marketable borrowings/repayments(-)BillsCoupons

Nonmarketable

(2) Decrease in the cashbalance

-8.2 -44.6 4.5 -20.7 -17.5

8.9 48.6 3.2 14.5 21.2

11.0-.4

11.4-2.1

50.524.026.5-1.9

4.2-.34.5-1.0

2.0 -6.3 -3.1

15.46.29.2-.9

21.711.410.3-.5

.6 .7

Memo: Cash balanceat end of period 11.0 17.3 11.0 10.4

(3) Other 2 -2.7

Federally sponsored creditagencies net cash borrowing3

3.0FHLB

FNMA

2.3 -4.6

6.4 2.9

1.8 1.1

5.6 -4.4

-. 2

2.6 .7 2.9 -1.0

Farm Credit Banks

Other

1.7 1.2

.6 .3 -. 1 -- .1

e--estimated.f--forecast.1. Numbers reported on a not seasonally adjusted, payment basis.

2. Includes checks issued less checks paid, accrued items and othertransactions.3. Includes debt of Federal Home Loan Banks, the Federal Home Loan

Mortgage Corporation, Federal National Mortgage Association, theFederal Farm Credit Bank System, and the Student Loan MarketingAssociation. Excludes mortgage pass-through securities issued byFNMA and FHLMC.

III-11

Government Finance

Federal Sector. The staff estimates the combined federal budget

deficit at $44.6 billion in the current quarter, a record amount for a

third quarter. The Treasury intends to borrow about $50.5 billion in the

market during this quarter in order to fund the deficit and to build up

its cash balance in anticipation of another large deficit in the fourth

quarter. The staff expects the Treasury to borrow still more heavily in

the market during the October-December period; action on the debt ceiling

will be required since the temporary increase in the ceiling to $1.1 tril-

lion, enacted late in June, will expire on September 30.

Thus far this quarter, the Treasury has raised $32.6 billion through

marketable borrowing. The Treasury has had to rely on sales of bills and

notes because the Congress has not yet raised the statutory limit on bonds

with coupons exceeding 4-1/4 percent.1 The Treasury has raised about $10.4

billion by enlarging its regular bill auctions, $4.5 billion through the

sale of cash management bills that will mature in September, and $17.7 bil-

lion in note auctions including the mid-quarter refunding.2

Primary dealers have provided strong support to the market since mid-

year, as their overall positions in Treasury securities have registered a

1. Legislation to raise the limit from $70 billion to $110 billion isattached to the tax bill, now moving toward final consideration in boththe House and the Senate.2. Treasury Investment Growth Receipts (TIGRs)--a novel instrument intro-duced by Merrill Lynch--could enhance the demand for long-term Treasurysecurities. The new certificates represent participation in a trust of$500 million of 14 percent 30-year Treasury bonds due in 2011; they com-bine the features of zero-coupon bonds with the credit quality of U.S.Treasury securities. The TIGRs will be sold in two forms--serial issuescorresponding to the coupon interest on the Treasury bonds through 2006,and a 30-year callable issue corresponding to the last 10 interest pay-ments and the principal of the Treasury bonds.

III-12

$9.7 billion swing, from a small net short to a large net long (including

cash, futures, and forwards) through August 16. The Lombard-Wall failure

has heightened concerns about the RP market; besides highlighting again

the need for attention to credit risks, it has also brought to the fore

long-standing questions about the legal aspects of the RP contract. Mar-

ket reports suggest that the tiering that emerged in the RP market after

the Drysdale failure has persisted, and that firms without strong capital

positions are finding themselves cut from the lists of former RP creditors.

Borrowing by federally sponsored credit agencies totaled $9 billion

in the second quarter, and about $4 billion is estimated for July. FNMA

borrowing picked up to $2.9 billion in July in order to finance large net

purchases of mortgages and to build liquidity. In contrast, FHLBank bor-

rowing fell off to $600 million as an increase in deposit flows at thrifts

reduced their demands for advances.

State and Local Sector. Yields in the municipal bond market generally

have moved down about three-quarters of a percentage point since the last

FOMC meeting. Yields on revenue bonds have declined by less than those on

general obligation bonds, perhaps owing to the unusually large quantity of

revenue bonds sold last month. As a result, the spread between yields on

such bonds and on general obligations widened to about 100 basis points in

July, compared with 65 to 80 basis points during most of the first half of

the year.

Although the total volume of state and local government borrowing in

July receded from the record second-quarter pace, gross issuance of tax-

exempt bonds was $5.6 billion (seasonally adjusted), up slightly from the

second-quarter volume, with revenue securities accounting for an unusually

III-13

large 80 percent of the total volume. Mortgage revenue bonds--proceeds

from which are primarily intended to finance single-family housing--totaled

about $2.5 billion in July, the largest monthly volume since December 1980.1

STATE & LOCAL GOVERNMENT SECURITY OFFERINGS(Monthly totals or monthly averages, billions of dollars)

1981 1982

e fYear Q1 Q2 July August

--------------- Seasonally adjusted -------------

Total 6.80 8.45 9.35 8.70 9.40

Long-term 4.00 5.25 5.20 5.60 5.40Short-term 2.80 3.20 4.15 3.10 4.00

------------ Not seasonally adjusted ------------

Total 6.80 7.05 10.15 8.40 9.00

Long-term 4.00 4.40 5.90 5.40 5.20Mortgage revenue .60 .30 .95 2.35 2.00bonds

Short-term 2.80 2.65 4.25 3.00 3.80

e--estimate. f--forecast.

Demand for long-term municipal bonds by institutional investors has

remained relatively weak. Individuals have been the major purchasers of

new municipal bonds, partly through investments in shares of unit investment

trusts (UITs), and of municipal notes through tax-exempt money market funds.

Sales of UITs in July were at a record $1.1 billion, and UIT assets have

increased 25 percent thus far in 1982 to about $31 billion at the end of

1. Issuance of mortgage bonds likely was stimulated in part by falling inter-est rates which increase the attractiveness of mortgages provided throughthese programs. In addition, volume probably was boosted by a Treasury rul-ing that in effect increased the arbitrage income bond issuers can earn, aswell as by an IRS announcement that removed the uncertainty about the maxi-mum amount of such bonds that can be issued in each state this year underexisting law.

III-14

last month. Tax-exempt money market funds have grown even more rapidly dur-

ing 1982 to about $9 billion in assets--almost double the end-of-1981 total.

These funds have absorbed a major share of the growing volume of tax-exempt

commercial paper (currently about $1.7 billion outstanding).

Mortgage Markets

Interest rates in the primary and secondary mortgage market have fallen

since early July to the lowest levels of the year. In the primary market for

long-term loans, the average contract rate on new commitments at S&Ls for 80

percent, fixed-rate level-payment conventional home mortgages has declined

more than 40 basis points, to 16.44 percent. As discounts dwindled on mort-

gages underwritten by the federal government, the administration reduced

rate ceilings on standard FHA and VA home mortgages by one-half percentage

point to 15 percent, effective August 9.

With nontraditional financing techniques still prevalent in the pri-

mary market, interest rates paid at closing by many homebuyers appear to

have remained substantially below rates quoted on new commitments for con-

ventional fixed-rate mortgages. 1 At major institutional lenders, the con-

tract rate on all types of conventional first home mortgages closed in

early July averaged 15 percent, more than 180 basis points below the aver-

age rate then prevailing on new commitments at S&Ls for conventional fixed-

rate home mortgages. 2

1. Many home sellers have continued to provide financing at concessionaryrates, likely in return for a premium incorporated in home sale prices. Thelatest (April) survey by the National Association of Realtors estimatedthat 70 percent of sales of existing homes involved one or more creativefinancing techniques, with interest rates on loan assumptions, "buydowns,"and seller "takebacks" typically 3 to 4 percentage points below the market.2. This differential continues to reflect inclusion in the average closingrate of below-market-rate loans such as those with "blended" rates and loansfinanced with mortgage revenue bonds. Moreover, the closing rate itself(continued on page III-15)

III-15

Mortgage commitment and lending activity at depository institutions

has remained weak. At commercial banks, growth of real estate loans slowed

almost to a halt in July, and new mortgage commitments made by savings and

loan associations during June edged up only slightly. Growth in S&L hold-

ings of mortgage loans and mortgage-backed securities in June remained at

less than one-third the average monthly increase during the first quarter.

Both FNMA and FHLMC continue to expand existing programs and to intro-

duce new arrangements to accommodate innovations in the primary mortgage

markets. FNMA recently announced that, beginning September 1, FHA and VA

mortgages will be eligible for its swap program, which allows an institu-

tion to exchange existing mortgages--typically bearing low rates--for more

liquid mortgage-backed securities guaranteed by the agency. FNMA also has

begun to issue commitments to purchase graduated-equity home mortgages

(GEMs) for its own portfolio and has announced plans to issue and guarantee

securities backed by GEMs, beginning September 1.1 FHLMC has inaugurated

a program to issue and guarantee GEM participation certificates, with

Merrill Lynch and Salomon Brothers cooperating in the origination of the

mortgages and the sale of the certificates. FNMA and FHLMC expect the

shorter maturity and more rapid cash flow of GEMs to attract investors who

wish to avoid very long-term investments in an environment of volatile

interest rates.

somewhat overstates the average rate paid by borrowers to the extent thatit incorporates the full contract rate on "buydowns," including the portionof the contract rate paid by the home seller as well as that part paid bythe borrower.1. GEMs are fixed-rate mortgages involving scheduled gradual increases in

monthly payments, with increases applied entirely to reduction of principal.Compared with an otherwise equivalent 25- to 30-year conventional fixed-rateloan, a GEM loan substantially reduces the total interest cost to the home-owner and enables homebuyers to own their homes outright sooner.

III-16

CONSUMER INSTALLMENT CREDIT

(Seasonally adjusted annual rates)

1980 1981 1982

Ql Q2 May June

- - - - Percent rate of growth - - - - - -

Change in outstandings -- totalBy type:

Automobile creditRevolving creditAll other

0.5 6.4 1.8

0.42.5

-0.3

8.2 -0.78.1 -0.34.1 4.9

- - - - - Billions of dollars - - -

Change in outstandings -- total

By type:Automobile creditRevolving creditAll other

By major holder:

Commercial banks

Finance companies

All other

Extensions -- total

By type:Automobile credit

Revolving creditAll other

Liquidations -- total

1.4 19.9 6.0 15.7

0.51.4

-0.4

-7.28.40.2

9.6 -0.84.7 -0.25.6 7.0

2.313.14.5

306.1 336.3 326.0

83.5128.1

94.5

94.4140.1101.8

87.8139.898.4

7.46.22.1

0.0 -0.11.5 10.24.5 5.6

16.8 16.2

11.56.4

-1.1

-0.213.5

3.4

-1.210.56.9

350.5 350.4 356.8

97.9153.299.3

101.2150.398.9

98.2160.398.3

304.6 316.5 320.0 334.8 333.6 340.7

Memo:

Ratio of liquidations todisposable income (percent)

Ratio of extensions to total

retail sales (percent)

16.7 15.7 15.1 15.6

32.3 32.7 31.3 32.7

15.5 15.8

32.2 33.3

4.8

5.810.4

1.5

5.1

9.110.8-0.8

4.9

6.210.1

1.6

III-17

Consumer Credit

Consumer installment credit outstanding expanded in June at about

the same 5 percent seasonally adjusted annual rate as in May. For the

full second quarter, consumer credit grew at a 4-3/4 percent rate, up from

1-3/4 percent in the first quarter. Indications of a rebound in credit

growth at banks suggest that the moderate overall advance continued into

July despite the likelihood of weaker expansion at auto finance companies

and retail stores.

The revolving credit component advanced at a 10 percent rate in June,

the third consecutive month of expansion at that pace. Stepped-up increases

of such credit at commercial banks and retailers since February have out-

weighed sluggishness in gasoline-card credit that has reflected recent

actions taken by several gasoline companies to discourage or preclude the

use of gasoline credit cards.

Delinquency rates on consumer installment loans at commercial banks

dropped during the second quarter to their lowest level in nine years. A

steady decline in this series since the third quarter of 1980 has been

interrupted only briefly by a small rise in the fourth quarter of 1981.

Delinquencies usually climb during a recession, but this pattern has not

been repeated in 1981-82, in large part because banks did not relax their

tightened credit standards following the 1980 recession. Similarly, the

delinquency rate on auto loans at major finance companies fell in the

second quarter to its lowest level since the series was begun in 1966.

Personal bankruptcies also declined fairly sharply in the second quarter,

when the number of cases filed was 7 percent below the peak first-quarter

total.

INTERNATIONAL DEVELOPMENTS

Foreign Exchange Markets

As shown in the upper panel of the chart on the next page,

the weighted average value of the dollar has shown substantial vari-

ability during the last several weeks but has remained almost unchanged

on balance since the last FOMC meeting. While the direction of exchange

rate changes closely paralleled interest rate movements on a daily

basis, overall there has been a substantial relative decline in dollar

interest rates. The strength of the dollar in spite of declining

interest rate differentials apparently reflected its attractiveness as

a safe haven currency in the face of market anxieties over the bank-

ruptcy of Banco Ambrosiano in Italy and the insolvency of the German

firm AEG Telefunken, as well as the Mexican financial crisis.

As shown in the lower panel of the chart, the differential

between rates on U.S. CD's and average foreign interbank rates declined

by about 500 basis points and turned negative for the first time since

November 1981. Eurodollar interest rates on maturities up to 1 year

fell by 2-1/2 to 4 percentage points during July, and have fallen

an additional 1-1/2 to 2 percentage points following the recent dis-

count rate cut. Several countries, in particular the United Kingdom,

Switzerland, Canada, Belgium, and France, have experienced declines

in short term rates of 1 to 2 percentage points during the last six

weeks, while no interest rate changes have occurred in Japan and

Germany.

IV-1

STRICTLY CONFIDENTIAL (FR)Class II FOMC

IV-2 8/18/82

WEIGHTED AVERAGE EXCHANGE VALUE OF THE U.S. DOLLAR March 1973=100Daily series 122

- 120

- 118

S116

-- FOMC - 114June 30

- 112

f l 1 1 1 110

II1111i 11111ii 11111111 ill IIilniI I l111111 i l1 i nIII mi iiii II i I IIIIII lii l Iil 108

3-MONTH INTEREST RATES

June

1982August

IV-3

. The Desk intervened on one occasion,

purchasing $6 million equivalent of yen and $5 million equivalent

of marks.

In early August, the Mexican government substantially raised

administered prices on certain foods and gasoline, and this was quickly

followed by labor union demands for increased wages. Conversions

from dollars to pesos accelerated and the Bank of Mexico found it

increasingly difficult to support the prevailing level of the peso.

. On August 5 the Mexican central bank announced

a new two-tier exchange rate system for the peso. A preferential

rate was established for most food and other "priority" imports,

and some private debt servicing. The preferential rate was set at

49 pesos per dollar (the previous market rate) and is expected to

IV-4

be depreciated gradually. The free market peso fell sharply following

the announcement, with prohibitive bid/asked spreads and virtually

no trading for several days. The establishment of the two-tier

exchange rate system failed to stop the drain on Mexico's foreign

exchange reserves, as rumors that controls would soon be instituted

were widespread, causing liquidation of dollar balances at Mexican

banks. Consequently, the Mexican authorities announced on August 12

that foreign exchange markets in Mexico were being closed, that banks

were prohibited from transferring Mexican dollar accounts out of the

country, and that withdrawals from Mexican dollar accounts could

only be taken in pesos. In U.S. markets, the peso is trading at about

85 per dollar, representing a 40 percent depreciation during August

and 70 percent since the beginning of 1982. Since formal exchange

markets remain closed in Mexico, street trading has reportedly taken

place in excess of 100 pesos per dollar. On August 17 the Mexican

Finance Minister announced that $3.5 billion of foreign credits had

been obtained or were in advanced stages of finalizing, including

$1 billion from advance oil sales to the United States, $1.5

billion from western central banks, and $1 billion from the Commodity

Credit Corporation.

IV - 5

U.S. International Transactions

U.S. Merchandise Trade. In June the U.S. merchandise trade

deficit was marginally greater than in May but the deficit for the

second quarter as a whole ($20 billion at annual rate) was slightly

smaller than in the first quarter. Exports in the second quarter were

about unchanged from low first quarter levels and imports declined

somewhat.

The value of agricultural exports increased slightly in the

second quarter, with the volume of shipments up by 4 percent (primarily

corn and soybeans) while the average export prices of most major

commodities continued to decline in response to large supplies and

moderate demand.

U.S. Merchandise Trade*

1981 1982Year Q3 Q4 Q1 Q2 May June

Value (Bil. $, SAAR)Exports 236.3 230.8 230.4 222.4 222.5 228.8 229.1Agricultural 44.3 39.8 42.4 42.0 42.4 43.8 41.6Nonagricultural 192.0 191.0 188.0 180.4 180.1 185.0 187.4

Imports 264.1 262.2 267.1 246.7 242.9 254.7 259.2Petroleum 77.6 72.6 72.4 62.6 53.7 50.4 61.4Nonpetroleum 186.5 189.5 194.7 184.1 189.3 204.3 197.7

Trade Balance -27.9 -31.4 -36.7 -24.2 -20.5 -26.0 -30.1

Volume (Bil, 72$, SAAR)Exports - Agric. 18.1 16.7 18.6 18.5 19.2 19.9 18.9

- Nonagric. 70.5 69.3 66.6 62.6 63.0 64.4 66.2

Imports - Petroleum 5.9 5.7 5.8 5.0 4.5 4.3 5.1- Nonpetrol. 72.1 73.9 76.3 69.8 72.5 78.2 76.8

*/ International Transactions and GNP basis. Monthly data are estimated.

IV - 6

Nonagricultural exports were little changed in value or volume

between the first and second quarters. In response to weak foreign

demand, lower primary commodity prices, and the decreasing competitive-

ness of U.S. goods as the dollar appreciated, various categories of

exports declined (civilian aircraft, metallurgical coal, construction

machinery) or continued at low first-quarter levels (other industrial

materials,particularly metals, paper, textiles). However, several items

increased strongly in the second quarter, particularly computers and

parts, and electrical/electronic machinery and parts.

The decline in imports in the second quarter was primarily the

result of a drop in oil imports. The volume of oil imports dropped

10 percent from first quarter rates to the lowest level since the

second quarter of 1972 as U.S. demand slackened and as domestic stocks

were drawn down from high levels. The average oil import price declined

about $1.65 per barrel to average $30.53 per barrel. Spot prices for both

crude and products slipped to about $3 per barrel below official prices

of most OPEC countries. OPEC failed to agree on a new pricing and out-

put structure at its meeting on July 9-10.

Despite the sluggishness of U.S. economic activity, nonoil imports

turned up in the second quarter. Volume increases were particularly

1981 1982 1982Oil Imports 2Q 3Q 4Q 1Q 2Q Apr. May June

Volume (mbd, SA) 6.52 5.90 5.99 5.33 4.82 4.35 4.55 5.38Price ($/BBL) 35.62 33.27 32.4 32.17 30.53 30.56 29.98 30.94Value (Bil. $, SAAR) 83.2 72.6 72.4 62.6 53.7 49.2 50.4 61.4

IV - 7

strong in foods and machinery (both from low first quarter rates).

Automotive imports from Japan decreased slightly while imports from

Germany and other countries rose somewhat from first quarter levels.

Partly offsetting these changes were declines in imports of consumer

goods and of industrial supplies (particularly steel and steel making

materials, other metals and natural gas). While total steel imports

decreased somewhat in the second quarter,it appears that imports from

Common Market countries rose while imports from Japan and other

countries declined.

U.S. International Capital Transactions. U.S. banking offices

(including IBFs) increased their net claims on their own foreign offices

by $2 billion in July and by $5 billion in early August (monthly average

basis, see line 1 (a) in the table below.) A sizable increase in Euro-

International Banking Data(billions of dollars)

1980 1981 1 9 8 2Dec. Dec. Mar. May June July Aug.4/

1. U.S. Offices' BankingPositions Vis-a-vis OwnForeign Offices 1/(a) Total 6.5 9.2 11.0 12.3 16.6 14.6 9.6(b) U.S.-Chartered Banks -15.2 -8.9 -4.2 -0.7 2.8 1.7 -0.5(c) Foreign-Chartered Banks 21.7 18.1 15.2 13.0 13.8 12.9 10.1

2. Credit Extended to U.S. Non-bank Residents by ForeignBranches of U.S. banks 2/(a) Total 4.2 13.2 13.8 14.9 14.2 14.4 15.7(b) New York Banks Only 2.7 8. 9.1 10.0 9.7 10.1 10.9

3. Eurodollar Holdings of U.S.Nonbank Residents 3/ 60.8 93.( 103.9 113.3 n.a. n.a . n.a.

1/ Average of Wednesdays, net due to own foreign office = (+).2/ Daily averages.3/ End of month.4/ Through August 4.

IV - 8

dollar borrowing by one U.S. money center bank to offset runoffs of

its domestic CDs was exceeded by net outflows from both U.S. and foreign-

chartered banks. The surge in net advances may have been prompted by

unusually high spreads between the cost of issuing domestic CDs and

returns available on placements in the Eurodollar interbank markets.

The functioning of the international interbank markets has been little

affected by either the Banco Ambrosiano scandal or the rumors of size-

able loan losses for Canadian and German banks. In particular, U.S.

regional banks, which in the aggregate are large net placers of funds in

those markets, have not reduced advances to their foreign branches

over the last two months.

The Eurodollar CD market also continued to function smoothly.

At the end of July Continental Illinois was removed from the list of

prime names in the secondary market for Eurodollar CDs, but reportedly

no further tiering of rates paid by other U.S. issuers of Eurodollar

CDs has developed. There has been no evidence that investors have

run off Eurodollar CDs in a flight to quality. Yields on prime Euro-

dollar CDs have remained at a level of 30 to 60 basis points above prime

domestic CDs. Money-market mutual funds, which hold about 40 percent

of total Eurodollar CDs outstanding at London branches of U.S. banks,

have not reduced their holdings of such obligations.

Loans to U.S. nonbank residents at foreign branches of U.S.

banks have risen sharply over recent weeks as the LIBOR rate fell

sharply relative to the prime rate -- see line 3 in the table above.

These loans are concentrated at a small number of banks, mostly New

York banks, that follow a practice of booking LIBOR-priced loans in the

IV - 9

Caribbean and booking prime-priced loans at the head office. As the

customers of these banks exercise their options under credit arrange-

ments to switch pricing formulas,the booking location is also shifted.

During June, as the differential between the prime rate and the 3-month

LIBOR narrowed by 200 basis points, branch loans fell. This decline

has now been reversed as the differential between LIBOR and prime

interest rates reopened.

Eurodollar holdings of U.S. nonbank residents continued to grow

at a rapid pace between March and May (most recent data available). In

the first five months of the year such holdings increased by $20 billion

to a level of $113 billion. In the March-May period holdings of Euro-

dollar CDs issued by London Banking offices increased particularly

rapidly, despite a cessation of the growth of holdings by money-market

mutual funds.

IV - 10

Summary of U.S. International Transactions(in billions of dollars)

Private CapitalBanks

1. Change in net foreign positions of bankingoffices in the U.S. (+ - inflow)

Securities2. Private securities transactions, net

a) Foreign net purchases (+) of U.S.corp. bonds

b) Foreign net purchases (+) of U.8.corp. stocks

c) U.S. net purchases (-) of foreignsecurities

3. Foreign net purchases (+) of U.S. Treasuryobligations 1/

Official Capital4. Changes in foreign official reserves assets

in U.S. (+ = increase)

a) By areaG-10 countries and SwitzerlandOPECAll other countries

b) By typeU.S. Treasury securitiesOther 2/

5. Changes in U.S. official reserve assets(+ - decrease) 3/

Other transactions (Quarterly data)6. U.S. direct investment (-) abroad7. Foreign direct investment (+) in U.8.8. Other capital flow (+ = inflow) 4/ 5/9. U.S. current account balance 5/

10. Statistical Discrepancy 5/

1981Year

-34.7

1.4

2.1

4.7

-5.5

2.5

5.1

-10.812.73.3

5.0.1

-3.3

-8.721.3

-13.94.5

25.8

1 9 8 1

3.3 -19.9

-2.5

.1

.2

-2.9

-.8 1.1

-5.5 8.1

-5.52.5

-2.5

-4.6-. 9

-. 1

-1.04.5

-1.60.9

-0.4

.91.95.4

4.43.7

-. 4

-1.09.3-3.3-0.99.5

1982

-1.0 -13.9

2.0 1.1

-2.9 2.2

-6.8 -4.65.0 2.7

-1.1 4.1

-1.3 -2.1-1.6 4.3

.1 -. 7

-1.11.0

-10.61.2

11.2

n-e-n.a.

n.a.n.a.na..

19 8_2

Apr. a Jun

-4.1 -5.1 -4.8

.7 1.5

.7 .8

.2 .3

-. 1 .3

-. 7 1.6

-1.2 1.5 2.0

-4.1 -1.01.5 .51.3 1.9

-2.6 .11.4 1.4

-1.6 .6

n.a.

n.a.

n.a.na.e.

n.a.n.a.n.a.n.a.n.a.

.41.5

.2

U.a.n.a.n.a.n.a.n.e.

MEN0sU.S. -rchandise trade balance - part of ine 9

(Balance of payments basis, seasonally adjusted) -27.9 -7.8 -9.2 -6.1 -5.1 -0.4 -2.2 -2.5

/ Includes U.S. Treasury notes publicly ssued o vateor n riden.T/ Includes deposits tn banks, commercial paper, acceptaace. A borrowing under repurchase agre uts.7/ Includes newly allocated S'o of $1.1 billion in Janary 1979; $1.2 billion in Jaary 1980, and

$1.1 billion in Janury 1981.4/ Includes U.S. govermnt assets other than official reserves, transactions by naoabamkin concerns,

allocations of SDRs, and other bakig and official transactions not sbow elsewhere.5/ Includes seasonal adjstment for quarterly data./ Less than $50 million.

NOTE: Details may not add to total becase of rounding.

. M - -I

IV - 11

Foreign Economic Developments. There have been no clear signs in

any foreign industrial economy that a recovery is underway. However in

the United Kingdom, where industrial production (s.a.) increased .6 per-

cent in the second quarter, hut was negative in June, the slowdown in

activity may have bottomed out. Industrial production (s,a.) fell in

Italy, Germany and Japan in the second quarter of this year. In Canada,

industrial production, though it rose in May, is still below its May

1977 level.

Although inflation abroad has eased substantially since last year,

the progress has not been uniform. The first-half rate of increase in

the CPI for the 10 foreign industrial countries was about 8.5 percent,

compared with 10.5 percent for the first half of 1981. In Canada and

France the rate of consumer price inflation in the second quarter was

virtually unchanged from the high rates reached in the second quarter of

last year. In the other major industrial countries there have been sub-

stantial declines.

The sluggish state of economic activity abroad has been reflected

in an improvement in current-account positions in some of the major

foreign industrial countries this year relative to 1981. In Japan, the

current-account surplus (s.a.) for the first half of this year was $3-1/2

billion as compared with $1 billion for the same period last year. The

first-half surplus, however, was below many earlier forecasts. In Ger-

many, the current account (s.a.) showed a small surplus in the second

quarter. For the first half of this year the current-account deficit

was $0.4 billion as compared with $6.7 billion for the same period last

year. Weak domestic demand is the primary factor behind the sharp rise

IV - 12

in Canada's trade surplus in the first half of this year. In France

and the United Kingdom, however, both the trade and current-account po-

sitions showed some deterioration.

Individual Country Notes. In Japan, the authorities have contin-

ued to struggle with the effects of weak demand in both domestic and

external sectors. Although industrial production in June recovered the

ground lost in May's sharp drop, the average level for the second quar-

ter was still 7 percent (s.a.a.r.) below the first-quarter level. The

mid-July assessment of the economy by the Japanese Economic Planning

Agency (EPA) noted recent increases in inventories and deterioration of

labor-market conditions as particularly troubling developments that may

endanger a hoped-for recovery of domestic demand later this year. (In

June, unemployment reached 2,5 percent (s.a.), its highest level in 16

years.) Stagnation in production and shipments of manufactured goods

was attributed primarily to reduced export demand.

The authorities appear to be stymied in the use of conventional

demand-management tools to stimulate domestic demand by concern over

budget deficits and weakness of the yen. Recently released budget fig-

ures for the FY 1981 (which ended in March) revealed a revenue short-

fall of some ¥3 trillion (about $11 billion equivalent); some of this

shortfall has been financed by controversial stop-gap measures includ-

ing sales of long-term government bonds from the Ministry of Finance

debt consolidation fund directly to the Bank of Japan. Although the

Bank of Japan has guided short-term interest rates upward in recent

months (by a total of about 80 basis points) and recent declines in

U.S. short rates have closed the short-term rate differential to about

IV - 13

3-1/2 percentage points, the yen has failed to strengthen.

Price developments in Japan continue to be favorable. The CPI

fell in July by a full percentage point, and in recent months consumer

prices have been moving ahead at only slightly above a 2 percent annual

rate. Wholesale-price inflation has been even more moderate at about 1

percent (a.r.).

The June trade surplus was virtually unchanged from that of May

at about $1.7 billion (s.a.), but the current-account surplus widened

in June by about $500 million to $1 billion. An important element in

the June increase was improved net investment earnings that are related

to recent long-term capital outflows from Japan. These capital outflows

continued strongly in June as Japanese purchases of foreign securities

and non-residents' sales of Japanese securities together produced a net

outflow of almost $900 million.

Industrial production in Germany declined again in June, the third

consecutive monthly decline. The second-quarter average of the index

matches previous low points of the current recession. The rate of unem-

ployment has continued to rise through July, when it reached 7.8 percent

(s.a.). Recent survey data suggest that views on business conditions

have once more taken a turn for the worse. Corporate insolvencies dur-

ing the first half of this year were 50 percent higher than in the com-

parable period last year.

The rate of consumer-price inflation, which earlier this year had

been slowing, has accelerated again in the summer months averaging over

7 percent (a.r.) for the June-July period.

The current account (s.a.) showed a small deficit in June, after

IV - 14

small surpluses in the preceding three months. For the first half of

this year, the cumulative deficit was only $0.6 billion compared to a

deficit of $6.7 billion in the first half of last year.

The rate of growth of Central Bank Money continued in June near

the upper limit of the Bundesbank's 4 to 7 percent target range.

This year's negotiations among the government coalition partners

about the 1983 federal budget were concluded in July. The new budget

provides for only 2 percent growth in real spending, compared with 5.5

percent in 1982, and new borrowing of DM28.5 billion, compared with

DM34 billion in 1982. The budget contains large cuts in spending on

social services such as unemployment benefits and pensions. Defense

spending is budgeted to rise by 4.1 percent. The underlying assumption

of 3 percent real GNP growth is considered optimistic by private fore-

casters.

In the United Kingdom, industrial production fell in June by 1-1/2

percent (s.a.) after a percent rise in May. The June industrial pro-

duction level was the same as that recorded in June 1981. Real GDP

growth has been positive but small in recent quarters, and the pace of

recovery in U.K. economic activity has not been sufficient to lower the

unemployment rate. In fact, the unemployment rate has continued to

climb and stood at 12.3 percent (s.a.) in July -- 1.5 percentage points

higher than a year earlier, and nearly twice the rate prevailing in July

1980.

Latest data indicate a further slowing of inflation in the United

Kingdom. Between April and July, consumer prices increased only 4 per-

cent (a.r.). The July consumer price index was 8 percent higher than

IV - 15

its year-earlier level.

In the first six months of this year, the U.K.'s trade account

registered a surplus of $ 3/4 billion and the current-account surplus was

some $2 billion. Both figures are down sharply from 1981 levels. Be-

tween the second quarters of 1981 and 1982, export volume rose about 5

percent while the volume of imports increased over 14 percent.

In mid-July, the London clearing banks lowered their base rate

from 12 to 12 percent and at the beginning of August the rates were

reduced another percentage point. On August 18, clearing banks low-

ered their base rates to 11 percent. Bank of England actions to lower

short-term money market rates preceded the recent declines in the clear-

ing banks' base rates.

French economic growth turned negative in the first quarter, after

averaging nearly 3 percent (s.a.a.r.) in the previous three quarters.

Growth in consumer expenditure remained strong at over 5 percent. Ex-

ports and residential investment were very weak, with expenditure de-

clining by well over 10 percent in each case. Consumer-price inflation

in the second quarter accelerated to 13 percent from 11.8 percent in

the first quarter.

Although French economic policy had been slowly changing emphasis

since the first of the year due to high inflation rates and external

payments problems, the French did not formalize the change until the

June devaluation of the franc. Prices and wages will be frozen until

November and controlled for at least a year thereafter. Deficits in

both the central government and social security budgets are to be re-

duced. Investment is to replace consumption as the key sector through

IV - 16

which the economy will be stimulated. No changes were announced for

monetary targets or credit controls.

Led by a sharp rise in exports, real GDP in Italy rose 1.4 percent

(s.a.) during the first quarter of this year. However, part of this

growth is believed to reflect inaccurate seasonal adjustment. Infla-

tion has slowed down noticeably. In June, wholesale prices were about

12 percent above their year-earlier level, compared with a 17 percent

rise in the previous 12 months. Consumer-price inflation has registered

a smaller decline: in the year ending in July, the CPI was 16 percent

above its year earlier level, compared with a 19 percent rise in the

previous year.

On August 7 the Spadolini government fell as the Socialists with-

drew from the coalition government. One of the last acts of the govern-

ment was to present a package of indirect tax increases designed to re-

duce the 1982-83 budget deficits. The tax changes involved increases in

various VAT rates, some production taxes, corporate tax rates and pen-

sion contributions. These tax increases are supposed to produce a gov-

ernment deficit of 60 trillion lire in 1982 (about 13 percent of GDP)

and 63 trillion lire in 1983. These changes were made by decree laws,

which are effective immediately and must be passed by the Parliament

within 60 days (in this case, by September 30). The dissolution of the

government will complicate the passage of these laws.

In Canada, industrial production (s.a.) rose almost 1 percent in

May -- representing the first rise in this index in ten months. Unem-

ployment has continued to climb to new post-depression highs. In July,

IV - 17

the unemployment rate jumped almost 1 percentage point to 11.8 percent.

Consumer-price inflation, which has been in double digits since

mid-1980, still remains high. CPI inflation on a year-over-year basis

was 10.8 percent in July as compared with 11.2 percent in June.

In June, the Canadian trade balance (s.a.) posted a surplus of

$1.6 billion. This brings the cumulative surplus for the first half to

$6.6 billion, which is almost $1 billion more than the surplus for all

of last year.

The Belgian government has recently announced preliminary plans

for the 1983 budget. In an effort to reduce the government borrowing

requirement next year to 10.5 percent of GNP, public spending will be

curbed and indirect taxes will be raised. This year the borrowing re-

quirement is expected to be over 11 percent. At the end of July the

National Bank of Belgium announced a reduction in its discount rate of

one-half percent to 13.5 percent. This change was in response to lower

market rates of interest.

Mexico. The recent deterioration in Mexico's external financial

position had its origins in policies implemented since 1978. At that

time expansionary policies adopted to promote employment yielded a

growth rate averaging over 8 percent in 1978-81, but led to large public

sector deficits, accelerating inflation, and high import growth. A de-

cline in Mexico's international competitiveness, weakness in the world

oil market, a recession in the industrial countries, and an accelerated

rise in interest payments on the growing external debt as world interest

rates reached new highs, resulted in a current-account deficit of $12.9

billion in 1981, compared with. $7.6 billion in 1980.

IV - 18

In February 1982, the peso was finally allowed to depreciate sub-

stantially following a drain on Mexico's reserves. However, no support-

ing stabilization program was adopted and, instead, steps were taken to

cushion the impact of the devaluation, including a large across-the-

board wage increase. In the face of a renewed drain on reserves, the

Mexican authorities, on April 21, announced a program to reduce the

public sector deficit, tighten monetary policy, and bring down the cur-

rent-account deficit. The program was not vigorously implemented and

skepticism mounted about its adequacy, as well as about the Government's

ability and willingness to take further steps before a new President

takes office in December. When the Mexican government raised adminis-

tered prices on certain foods and gasoline early in August, fears of

rising wage demands and of possible controls were aroused, and capital

flight accelerated.

The peso was again allowed to depreciate substantially in August

and a dual exchange rate system was instituted, with a preferential rate

for certain imports and debt payments, financed primarily out of oil ex-

port earnings. The reserve drain continued, and transfers from foreign

currency denominated accounts to banks outside the country were banned

and such accounts were ordered paid only in pesos at the free market

rate.

The growing concern of foreign banks over the outlook for Mexico

is shown by the hardening of terms on Mexico's Eurocurrency borrowings

since late last year and by a sharp reduction in the flow of new credits

to Mexico since June. In June, a jumbo loan of $2.5 billion received a

IV - 19

poor response from the market and the lead managers were able to sell

down only about 15 percent of the loan. Some banks are reported to be

refusing to roll over maturing obligations. Mexico's total external

debt at mid-year was estimated at close to $80 billion, three-fourths

of which is owed to foreign banks.

REAL GNP AND INDUSTRIAL PRODUCTION IN MAJOR INDUSTRIAL COUNTRIES(PERCENTAGE CHANGE FROM PREVIOUS PERIOD, SEASONALLY ADJUSTED)

19801979 1980 1981

CANADA: GNP 2.9 .5 3.1IP 5.3 -2.0 1.3

FRANCE: GDP 3.7 1.1 .2IP 4.5 -1.1 -2.3

GERMANY: GNP 4.4 1.8 -. 3IP 5.3 -.1 12.1

ITALY: GDP 5.0 4.0 -.2IP 6.9 4.5 -2.5

JAPAN: GNP 5.2 4.2 3.0IP 8.3 7.1 3.0

UNITED GDP 1.7 -2.4 -2.2KINGDOM: IP 2.7 -6.6 t-5.0

UNITED GNP 2.8 -.4 1.9STATES: IP 4.4 r3.6 2.6

1.92.2

-.2iI .0

.4-1.2

2.33.6

.71.6

.9t2.4

198101 Q2 Q3 Q4

1.2 1.6 41.1 '.91.0 2.6 -3.1 -4.6

-.6 1.2 .2-1.5 .5 .3

.71.5

.5 -. 5 .7 .1

.9 -. 3 .0 $1.2

.8 +l.1 -1.7 2.6-.7 1.5 -4.9 4.5

.7 1.2 .7 1.71.7 1.3 1.6 2.6

-.4 -.41.4 .1l

1.9 -. 4 .5 11.32.0 .5 .3 i4. 4

198201 Q2

-2.0 N.A.-2.9 N.A.

-. 2 N.A.-2.5 N.A.

-. 2 N.A.1.3 -. 6

1.4 N.A.1.0 f1.4

.8 N.A.-. 9 t-1.9

.1 N.A.-. 4 .6

-1.3 .4-3.1 1 .8

1982MAR. APR. MAY ]UN.

* * * *

-1.2 -1.4 1.0 N.A.1-q

* * * *

.8 -.8 1.6 N.A.0

* * * *

1.9 -. 9 -. 9 -1.9

* * * *

,'1.6 >.1 r.6 -4.2

* * * *1

1.4 '1.9 -1.7 1.7

.* *

.3 .5

*

-1.5

* * * *

r.8 $1.l 1.7 -. 7(JULY) -. 1

*GNP DATA ARE NOT PUBLISHED ON MONTHLY BASIS.

CONSUMER AND WHOLESALE PRICES IN MAJOR INDUSTRIAL COUNTRIES(PERCENTAGE CHANGE FROM PREVIOUS PERIOD)

CANADA: CPIWPI

FRANCE: CPIWPI

GERMANY: CPIWPI

ITALY: CPIWPI

JAPAN: CPIWPI

UNITED CPIKINGDOM: WPI

1981Q1 Q2 Q3 Q4

3.2 3.1 3.0 2.52.7 2.2 2.1 1.2

3.0 3.3 3.9 3.21.4 4.3 4.3 2.1

2.2 1.8 1.2 1.23.9 2.3 2.1 1.8

5.2 4.4 3.0 4.65.0 5.1 3.5 4.0

1.1 1.5 .0 1.3-.7 1.1 1.4 ".1

2.4 4.9 1.7 2.53.0 3.4 2.1 2.3

1982Q1 Q2

2.5 3.11.4 2.0

2.8 3.12.7 2.6

1.5 1.41.8 1.3

4.0 3.13.3 2.0

1982APR. MAY JUN. JUL.

.5 1.4 1.0 .51.0 .4 .5 N.A.

1.2 .8 .71.0 .1 .9

.3N.A.

.2N.A.

MEMO:LATEST 3 MONTHS

FROM YEAR AGO

11.36.9

13.112.3

1.1 1.5.3 N.A.

15.713.4

1.0.2

1.7 3.22.2 1.7

2.0 .7 .3.6 .5 .4

UNITED CPI (SA) 2.6 1.9 2.8 1.9STATES: WPI (SA) 2.5 2.3 1.1 1.2

.2 1.0 1.0 N.A.i.1 .0 1.0 .6

TRADE AND CURRENT ACCOUNT BALANCES OF MAJOR INDUSTRIAL COUNTRIES#(BILLIONS OF U.S. DOLLARS; SEASONALLY ADJUSTED)

1980 1981

CANADA: TRADECURRENT ACCOUNT

FRANCE: TRADE+CURRENT ACCOUNT+

GERMANY TRADECURRENT

ITALY: TRADECURRENT

ACCOUNT (NSA)

ACCOUNT (NSA)

JAPAN: TRADE+CURRENT ACCOUNT

UNITED TRADEKINGDOM: CURRENT ACCOUNT+

UNITED TRADESTATES: CURRENT ACCOUNT

1981Q1 Q2 Q3 Q4

6.7 5.7 1.4 .8-1.6 -5.2 -1.2 -1.8

-14.2 -10.7 -2.5 -1.9- 4.2 -4.8 -1.7 .3

4.9 11.9 .2 3.1-16.5 -7.6 -4.4 -2.3

-22.3 k16.0 "4.6 -5.0-8.4 -9.1 -5.8 -2.3

.6 2.8-2.1 -. 2

-1.9 -3.1-1.3 -2.1

3.1 5.5-4.9 4.1

-4.0 -2.5.3 -. 9

1 08201 O?

2.9 3.7.2 N.A.

-2.8 -4.3-2.0 N.A.

5.0 5.3-. 8 .4

-6.0 -1.8K.A. N.A.

2.1 20.1 3.3 5.5 6.3 5.0 4.4 5.3"10.7 4.6 -1.0 2.0 2.5 1.1 .9 2.5

2.9 N.A. 3.9 2.4 N.A. .97.4 N.A. 5.9 4.4 N.A. 2.6

-25.3 -27.9 -4.3 -6.51.5 4.5 3.2 1.4

-7.8 -9.2.8 -. 9

.6 .11.3 .9

-6.1 -5.11.2 N.A.

1982APP. fAY JUN.

1.0 1.2 1.6* * *

-1.6 -. 5 -2.1* * *

1.1 2.2 2.0.2 .4 -. 2

-.5 -1.2 -.2* * *

1.9 1.7 1.71.0 .5 1.0

-. 2 .0.1 .3

-. 4 -2.2 -2.5* * *

# THE CURRENT

ACCO

S ES 1RVICS ANT~DD PRI ATS(ttITTTACTD

+ OUARTEPLY DATA ARE SUBJECT TO REVISION AND ARE NOT CONSISTENT WITH ANNUAL DATA.* COMPARABLE MONTHLY CURRENT ACCOUNT DATA ARE NOT PUBLISHED.

k .)